Supporting every single firm will just create a zombie business community

With no early recovery in the offing, the Government can’t avoid the inevitable — some firms won’t make it out alive, writes Colm McCarthy

LAST Thursday’s ESRI report should have ended wishful thinking about an early economic recovery. The authors were brave enough, two months earlier, to produce the first assessment of the damage, at a time when only a handful of fatalities had been reported and just before the lockdown commenced on March 27. They were too optimistic — the table shows their scenario in March and their current ‘baseline’ projection for 2020.

They now expect the deficit to reach €28bn for 2020, with more to come in later years. These numbers are worse than the downturn that followed the financial crash in late 2008.

The ESRI concedes that things could continue to be difficult moving into 2021, especially if the easing of lockdown results in a resurgence of transmission and a renewal of restrictions. Even if things go well in Ireland and a second surge here is avoided, failures in other countries will limit recovery.

Ireland has had, by European standards, a rather severe experience of the pandemic — fatalities relative to population, while lower than in the UK, have been ahead of many European countries. Several small countries, including Denmark, Greece and Portugal, have done better. The comparison with the UK is too flattering — the UK has the secondhighest excess fatality rate in the world, after Italy, according to the Financial Times on Friday.

It is far too early to draw conclusions but the success of public health measures in controlling the pandemic is reflected in economic costs — those countries which have been most effective at suppressing the virus have been able to restart economic activity at a brisker pace.

The weak US and UK response to Covid is a negative for Ireland since delayed recovery in these countries will inhibit exports and inward investment. The worldwide pattern of the pandemic suggests a better performance in east Asia than in Europe but there are concerns about less developed countries. Brazil, South America’s largest economy, is experiencing rapid growth in infection, and virologists have been expressing fears that south Asia and large parts of Africa will struggle to control the disease.

In a recent interview, Raghuram Rajan, who has worked as chief economist at the International Monetary Fund and as governor of the Indian central bank, dismissed the rosier expectations of a V-shaped recovery for two principal reasons. A process of deglobalisation had been under way prior to the onset of the pandemic and has been accelerated by a renewed outbreak of economic nationalism. International supply chains have been ruptured and may not quickly be repaired. He also stressed the adverse impact on consumer and business sentiment. Pervasive uncertainty is not good for either household consumption or private investment, and many governments are debt-constrained in seeking to plug the gap.

Proponents of the V-shaped narrative have argued that, since the downturn is mainly a supply shock deliberately engineered by governments for public health reasons, firms should be preserved since almost all were viable before the crisis struck. We need them around for the early recovery.

It now looks as if an early recovery is not in the offing but there are other flaws in the argument. Not all firms were in great shape before the downturn — high street retail has been suffering from online competition, pubs in Ireland have been closing for years as consumer preferences have shifted.

The public reaction to the pandemic may have altered permanently the composition of demand, even if recovery eventually arrives, to the detriment of firms in certain sectors. Close-contact businesses, including everything from nightclubs and rock concerts to restaurants and live sports events, may have to contend with a more cautious public. The international travel business seems to be facing a permanent shift to a lower trajectory as holidaymakers eschew long-distance travel, and firms discover that remote working is both feasible and less costly. Airports, city centre hotels and restaurants will suffer alongside airlines. Some firms have already announced that they will reduce their demand for office accommodation and rely more on staff working remotely.

Blanket extension of payroll support to firms and of forbearance by lenders, a prudent initial reaction, is beginning to morph into major bailouts by governments of favoured firms. Some of these are egregious: the Alitalia airline, a job creation scheme with wings, has been nationalised yet again by the government, preserving capacity in an industry which is not going to need it. Numerous French and German ‘national champions’ have been back to the trough and the problem, as ever, is not that governments pick losers, it is that losers will pick the government whenever circumstances permit. The European Commission has effectively suspended its policing of state aid rules, citing the pandemic, so it is open season for big-ticket corporate welfare.

Ireland is relatively immune since the Irish corporate landscape does not feature too many national champions. But this has not constrained lobbyists from promoting schemes of undiscriminating corporate welfare for smaller firms, which would see an across-the-board subvention of the SME sector. If Raghuram Rajan is right, this is not a good strategy. The new economy, post the pandemic, will

‘Some existing firms need to contract or fold, releasing resources’

not be a resuscitated replica of the old, and some existing firms need to contract or fold, releasing resources into a new economy which will look different.

At ground level, every business did not have equal survival prospects before the pandemic and fewer will survive the altered pattern of demand when it passes. Supporting every firm will create a zombie business community with the walking wounded limping along longer than they should.

This points to a welcome for some level of business failure, and the denial of state subvention to those with poor prospects. It is a real challenge to design policy instruments, perhaps some form of state equity rather than debt investment in small firms, better attuned to the realities.