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Building effective short-time work schemes for the COVID-19 crisis

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Via VOX EU

The international public-health response to the COVID-19 pandemic has put our economies into severe hardship. The economic crisis we are experiencing is highly unusual. This is not only because of the unprecedented scope and speed with which business activity has come to a halt, but also for the largely asymmetric effects it is having on different sectors of the economy, with some having experienced drastic contraction and others being under pressure due to labour shortages. And while the crisis is temporary in nature, its dynamics remain highly uncertain.

Governments around the world have been taking a range of policy actions to support their citizens and businesses. The choice of policy mix will have important consequences for the severity and length of the economic downturn, its distributional consequences, and for the timing and speed of the recovery. Keeping the economic fabric alive by preserving jobs and businesses is the best strategy to ensure a rapid recovery once the pandemic is over. 

As a key element of the countercyclical policy toolkit, short-time work is now at the centre of policy proposals and actions to tackle the current economic crisis. In this column, we build on the existing evidence, in order to put forward a strategy for the effective implementation of short-time work and complementary schemes in the current situation.

What is short-time work and when is it useful?

Short-time work – also called short-time compensation – is a subsidy for temporary reductions in the number of hours worked in firms affected by temporary shocks. Short-time work programmes allow employers who experience temporary drops in demand or production to reduce their employees’ hours instead of laying them off. Employees receive from the government a subsidy proportional to the reduction in hours. 

Hoarding labour in the firm during a temporary negative shock enables the firm to keep specific human capital within the firm and avoid the costly processes of separation and then of re-hiring and training when economic conditions improve. For workers, it preserves experience and specific human capital and avoids the often very long-term career costs of layoffs (Davis and von Wachter 2011, Schmieder et al. 2019). 

Without short-time work subsidies, labour hoarding may be suboptimally low during temporary shocks because of commitment issues and/or difficulties to move resources across time. Liquidity constraints, for instance, prevent firms from insuring workers and will generate inefficiently high separations. Well-designed and targeted short-time work schemes can therefore be an effective tool to save jobs and businesses and to accelerate economic recovery. 

The sharp contraction caused by the public-health response to COVID-19 is a textbook case for the use of short-time work: it combines a mandated reduction in hours of work in many sectors due to confinement measures and a massive liquidity crunch for firms. In this context, short-time work can be much more effective than other forms of insurance such as unemployment insurance or universal transfers, and more efficient than other forms of wage subsidies.

As a result, short-time work schemes are now at the heart of the policy response enacted by various countries. Those with well-established short-time work programmes, such as France, Italy, Germany, and Belgium, have seen massive increases in uptake, compared with even the Great Recession. For example: 

  • Estimates for Germany indicate that 2.35 million employees (almost 6% of total employment) will receive Kurzarbeit during the COVID-19 crisis, compared to 1.4 million at the peak of the Great Recession. Considering that Kurzarbeit cost approximately €5 billion in 2009 (Boeri and Bruecker 2011), we would expect spending on short-time work to climb to €8.4 billion today. 
  • In France, 730,000 employees (2.8%) are currently being paid by the French short-time work scheme. In contrast, 227,000 employees were on short-time work at the height of short-time work utilisation in 2009. 
  • In Belgium, 100,000 people were on short-time work at the peak of the Great Recession, while nowadays over 1 million are (22%). 
  • In the US, 26 states already have short-time work schemes in place. The availability of the schemes should be advertised more and their scope extended to all states.

Still very little is known about the effectiveness of short-time work. It has been used before, especially during the Great Recession, but in a limited set of countries. A few recent papers have analysed examples of short-time work programmes in Europe, shedding new light on fundamental questions around the functioning of these schemes. Using a combination of high-quality data and compelling identification strategies, Cahuc et al. (2018) study the French case, Kopp and Siegenthaler (2019) review the Swiss one, and Giupponi and Landais (2018) analyse the Italian Cassa Integrazione Guadagni, one of the oldest and largest programmes of this genre in Europe. 

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In Giupponi and Landais (2018), we exploit variation in eligibility rules across firms and show that short-time work has large positive effects on employment: firms receiving the subsidy experience a 40% reduction in hours worked per employee, and an equivalent increase in employment headcount. Evidence from the French and Swiss cases lines up with our findings in documenting positive effects on employment and on firm survival (Cahuc et al. 2018, Kopp and Siegenthaler 2019). 

Both our work and Cahuc et al. (2018) show that short-time work has strong effects on liquidity-constrained firms that face a temporary demand or productivity shocks. The programme enables these firms to engage in labour hoarding and recover more quickly after the shock, with positive medium-run effects on their workers. This is precisely the type of situation we are facing, which makes short-time work especially desirable. 

One may worry that, by subsidising the preservation of existing matches, short-time work may prevent workers to move from low- to high-productivity firms during recessions. In this way, the policy may have significant negative reallocation effects in the labour market. In our paper, leveraging rich spatial variation in treatment intensity across more than 600 local labour markets in Italy, we estimate how an increase in the fraction of workers receiving the subsidy affects employment outcomes in non-treated firms. 

Our results show that, despite short-time work having targeted predominantly low-productivity firms, reallocation effects are small. While such small reallocation effects were estimated among a much smaller number of workers than are involved today, we note that the current downturn is inherently a response to a public-health crisis and not an example of a market-led recession that is typically thought to generate ‘creative-destruction’ forces. 

In what follows, we build on this evidence and on the new challenges created by the current situation to propose a guideline for effective implementation of the scheme. 

How can short-time work schemes be best implemented in the current situation?

Set up timely payments to firms

In existing short-time work schemes, workers are typically paid in advance by firms, who are then reimbursed by social security via a transfer or a balancing out of contributions owed by the firm. The time it takes for firms to be reimbursed can vary substantially across countries: in France, it may take up to one month; in Italy, firms can balance out the amounts paid to the workers with contributions due the social security starting from the subsequent month; in Switzerland, short-time work is paid directly by the social security administration to the workers. 

In the face of the current liquidity crunch, it is essential that payments are provided directly by the administration, in order to relieve liquidity pressures on firms. 

Condition take-up on prohibition of dismissal

For short-time work to be effective and to reduce moral hazard by firms, take-up should be made conditional on the obligation for firms to retain their workers. The ability to prohibit dismissal is a key advantage of short-time work programmes compared to their closest alternative – ‘recall unemployment’ or ‘job attached unemployment’, where a laid-off worker is expected to return to their most recent employer after a short period on unemployment benefits. In the case of recall unemployment, it is hard to envisage a mechanism whereby firms are held to their commitment to recall workers since such a commitment can neither be monitored nor enforced.

Extend eligibility to temporary workers

In European countries with dual labour markets, flows in and out of employment pertain almost entirely to temporary work. To avoid sharp rises in joblessness amongst temporary workers, short-time work eligibility must be extended to them, at least for the duration of confinement measures. 

French authorities have extended eligibility to short-time work to workers on a temporary contract. Similarly, the rules that determine eligibility for the Belgian chômage temporaire for temporary workers have been relaxed.

Establish generous replacement rate (up to a cap) in non-vital sectors 

A key question in relation to the design of short-time work compensation is the size of the replacement rate, i.e. the fraction of foregone earnings due to hour reductions that are reimbursed by the administration. 

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In the current situation where production activity has been drastically reduced in response to a public-health crisis, the risk of opportunistic behaviour by workers and firms is limited. As confinement restrictions are progressively lifted, or in sectors where firms can already move to efficient ways of working remotely, moral hazard can be dealt with by imposing additional conditions, such as evidence of a significant shortfall in revenues. 

Absent moral hazard concerns, the benefit replacement rate can in principle be close to 100%, but full insurance at all levels of earnings is probably unwarranted. On the one hand, the severity of the crisis means that our societies will incur huge losses. While such losses can be smoothed intertemporally across generations, their unprecedented size requires that part of those losses are borne at the present time. On the other hand, with many businesses such as restaurants and shops now being shut, consumers will only spend on necessities. Consequently, as of now, there is no scope for stimulus and for maintaining living standards beyond what is needed for subsistence. In light of those considerations, a generous replacement rate of 80% or 90% up to a cap is probably the best design option. This is already the case in many existing schemes and in the newly established UK Coronavirus Job Retention Scheme. 

In any case, to make short-time work take-up incentive-compatible in the presence of unemployment insurance, the short-time work replacement rate must be more generous than the unemployment benefit one.

Provide flexibility in hour reduction 

Short-time work subsidies should be designed in such a way not to discourage flexible working, where possible; firms should be allowed to flexibly reduce their workers’ hours as needed. This is the case, for instance, in the Italian Cassa Integrazione Guadagni, the French Chômage Partiel and the German Kurzarbeit. It is not in the UK Coronavirus Job Retention Scheme: to be eligible for the subsidy, furloughed workers cannot undertake any work for their employer. This clearly encourages firms to furlough many if not all workers and discourages work-sharing in businesses that have some degree of activity. Keeping workers engaged with their professional activity, where possible, is beneficial for business continuity and workers’ human capital. 

Incentivise vital sectors to remain productive by introducing wage subsidies

A generous replacement rate may end up being costly if firms in vital sectors of the economy put their workers on reduced hours rather than delivering products and services of primary need for our societies. In most countries, the confinement measures explicitly identify ‘vital’ sectors, whose activity is critical to the COVID-19 response or deemed essential (e.g. health and social care, food and other necessary goods, transport, utilities, communication, and financial services) and which have to remain active throughout this period. To incentivise firms in vital sectors to remain productive, governments have the option to make them ineligible for short-time work or to introduce wage subsidies specifically targeting those industries.

Why recall or temporary unemployment is not the solution

In principle, recall or temporary unemployment could be seen as an alternative to short-time work to relieve liquidity pressures from firms, typically at a lower replacement rate. However, recall or temporary unemployment are not solutions, for two main reasons. First, firms cannot be credibly held to their commitment to recall their workforce after the shock, which is a key condition for a swift recovery. Second, neither recall nor temporary unemployment is as flexible as short-time work in allowing firms to flexibly reduce hours and keep some workers employed on a part-time basis, as and when required. 

Lengthen programme duration for entire confinement period and beyond

The efficacy of short-time work programmes depends critically on the duration of the shock and on firms’ expectations of the duration of the shock. When shocks are temporary, the effects of short-time work are larger and more protracted, since firms’ desire to hoard labour is greater for temporary shocks. Clearly, to be willing to hold onto their workforce, firms must know that they will be covered by the subsidy for the whole period of reduction in economic activity, which will likely last longer than the lockdown. 

It is therefore necessary to extend programme duration for the entire confinement period and beyond, and to communicate this to the business community. The UK Coronavirus Job Retention Scheme is currently open for three months, starting 1 March 2020. UK authorities announced that the duration of the scheme will be extended if necessary – a message that leaves too much uncertainty for businesses to make informed decisions.  

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Exit strategy

Right now, reducing economic activity is essential in the fight to contain the pandemic. But as the public-health crisis eases, how can we make sure that businesses revert swiftly back to their production activities without inefficiently holding on to short-time work? 

Short-time work policies are effective only to the extent to which they are temporary. Governments should therefore make sure that short-time work will be phased out progressively as conditions improve. At the same time, stimulus packages should be rolled out to boost demand and bring businesses back to sustained levels of production. 

Is this enough? 

Unfortunately, no. Short-time work programmes serve two objectives: to ensure employment continuity and to provide insurance to eligible workers. This will not prevent some categories of workers – especially those ineligible for short-time work – to become unemployed. It also will not guarantee that businesses will stay afloat if their liquidity will not allow them to meet all remaining non-labour costs.

Guarantee generous unemployment insurance for the laid-off and for those ineligible for short-time work 

Even if governments expand short-time work schemes and put in place restrictions on worker layoffs, recent data shows that a significant fraction of workers will lose their jobs and unemployment will still surge. This will especially be the case for workers who are not covered by short-time work, as is often the case for apprentices and managers (though some countries – like Italy – have extended coverage to previously ineligible categories of workers). It will also be the case for all self-employed individuals who are de jure independent workers but de facto economically dependent on a single firm. 

Guaranteeing social protection to workers whose incomes are affected through a generous unemployment insurance system will be necessary to allow them to make ends meet and to prevent dramatic increases in poverty. For example, the UK government has launched the Self-employment Income Support Scheme, which allows self-employed individuals or members of partnerships to claim a taxable grant worth 80% of their trading profits up to a maximum of £2,500 per month for three months. The US Senate has approved a stimulus bill that extends unemployment benefits by 13 weeks and guarantees a four-month top-up of state unemployment benefits by an additional $600 per week. Benefit expansions include furloughed employees and gig workers.

Solve firms’ liquidity needs to cover non-labour costs

Efforts to provide social protection to workers and to support firms to keep all employees on their payrolls will be in vain if we do not support businesses in covering maintenance and other fixed costs. Subsidising furloughs without ensuring business continuity would entirely miss the purpose of short-time work programmes, which is to maintain productive matches alive so that businesses can get back to their productive activities as soon as confinement measures are eased. 

One potential measure to provide liquidity to firms is to introduce VAT reductions or exemptions for sales made during the confinement. A measure of this sort would allow firms to frontload revenues from sales that they would have otherwise made and cashed in in the future. Keeping firms alive is now essential to ensure a swift recovery.

Authors’ note: Financial support from the sponsors of VisitINPS is gratefully acknowledged. The findings and conclusions expressed are solely those of the authors and do not represent the views of INPS.

References

Boeri, T, and H Bruecker (2011), “Short-time work benefits revisited: Some lessons from the Great Recession”, Economic Policy 26(68): 697–765.

Cahuc, P, F Kramarz and S Nevoux (2018), “When short-time work works”, CEPR Discussion Paper 13041.

Davis, S J, and T von Wachter (2011), “Recessions and the costs of job loss”, Brookings Papers on Economic Activity 43(2): 1–72.

Giupponi, G, and C Landais (2018), “Subsidizing labor hoarding in recessions: The employment and welfare effects of short-time work”, CEPR Discussion Paper 13310.

Kopp, D, and M Siegenthaler (2019), “Short-time work and unemployment in and after the Great Recession”, KOF Swiss Economic Institute Working Paper 462.

Schmieder, J, T von Wachter and J Heining (2019), “The costs of job displacement over the business cycle and its sources: Evidence from Germany”, working paper.


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