Small business failures in Europe would have doubled without pandemic relief, analysis finds

A lone diner takes his lunch on the terrace of a restaurant in Paris on June 15, 2020, as the country was just beginning to ease its strict coronavirus lockdown. (AP Photo/Francois Mori, File)

An analysis of 17 countries in Europe and Asia found that the COVID-19 crisis hit small- and medium-sized businesses hard: In the absence of government support, the 2020 bankruptcy rate would have almost doubled to 18% on average, with even higher rates in the hardest hit sectors and countries, researchers found.

Government interventions in most countries has cushioned some of the blow, and despite the severity of the shock, the banking sector showed resiliency. Banks did not appear to be significantly impacted by the rise in loan defaults, according to a recent National Bureau of Economic Research working paper co-authored by Prof. Pierre-Olivier Gourinchas of UC Berkeley’s Haas School of Business and Berkeley Economics.

“On the whole, the pandemic has been devastating for small businesses,” said Gourinchas, faculty director for the Clausen Center for International Business and Policy. “However, the resiliency of the banking sector is a ‘relative good news’ in a world of bad news.”

On the whole, the pandemic has been devastating for small businesses. However, the resiliency of the banking sector is a ‘relative good news’ in a world of bad news. —Pierre-Olivier Gourinchas

The analysis underscores how critical government support has been buffering the full impact of the COVID-19 pandemic. In addition to the severe impacts on individual health, the pandemic has severely disrupted economic systems around the globe. Small businesses, which often lack the liquidity to survive for several months of depressed demand, are particularly at risk of going bankrupt.

Gourinchas wanted to examine the pandemic’s impact on the financial health of small-and medium-sized enterprises (SMEs). With co-authors Ṣebnem Kalemli-Özcan of the University of Maryland and the International Monetary Fund, Veronika Penciakova of the Federal Reserve of Maryland, and former UC Berkeley doctoral student Nick Sander, now at the Bank of Canada, he analyzed the rate of small business failures across countries during the pandemic and estimated how different government interventions would have affected these failure rates.

“We became concerned that SMEs could fall through the cracks because they typically have few liquid assets, limited access to bank credit, and don’t have big equity buffers,” Gourinchas said. “If they failed in large numbers, then it would make the recovery that much harder.”

Modeling the pandemic’s impact

The researchers created a model of a business’s cash flow and liquidity following the demand and supply shocks during the eight-week period beginning in March when countries were in a period of lockdown. They applied their model using data on 15 European countries,* plus Japan and Korea, selected for good available data coverage on business characteristics such as revenue, total wages, and number of employees (from the ORBIS global dataset).

Across the countries in their sample, the bankruptcy rate rose to 18% during the COVID crisis, up from an average rate of 9% before the pandemic, the researchers found. Sectors with more customer-facing interactions, such as the food services or entertainment industries, were hurt the most. Likewise, countries with more of their economy tied to these sectors fared worse. For example, bankruptcy rates increased by 13 percentage points in Italy, but only by 5 percentage points in the Czech Republic. Following numerous government interventions, the actual increase in 2020 bankruptcies is expected to be much smaller.

The impact of failing small businesses could have had fallout implications for the banking sector, as the incidence of default, or non-performing loans, increased. The researchers estimated that non-performing loans increased across countries from a low of 2 percentage points in Belgium up to a high of 10 percentage points in Italy. The COVID crisis also had the potential to reduce banks’ ratio of capital to assets. Known as the CET1 capital ratio, the European Union benchmarks an adverse financial situation as when a bank’s CET1 ratio declines by 4 percentage points. The researchers estimated that the COVID economic crisis reduced the CET1 ratio from about 14.7 percentage points to about 13.9 percentage points, indicating that the impact on the financial sector did not approach crisis levels.

“Banks in many countries have become much more resilient in the aftermath of the 2008 financial crisis. International regulation required that they build much stronger buffers, precisely so that they could be able to withstand shocks of that nature,” Gourinchas said. “Well, the real test came in, and so far, the banking sector is not collapsing.”

Analyzing different interventions

Our paper suggests that the right kind of policy may need to be quite generous upfront, and then reclaim some of the subsidies later when the dust settles. —Pierre-Olivier Gourinchas

Many countries attempted to ease the negative effects on small businesses by providing temporary assistance, such as interest-free loans, tax deferrals, or loan guaranties. The researchers modeled how several different government policies would have affected the SME bankruptcy rate.

First, they modeled a scenario where a government targeted financial support specifically to at-risk firms that would have survived if not for the crisis. They estimated that, at a cost of 0.5% of GDP, the bankruptcy rate would have been similar to the pre-COVID rate—essentially erasing the effect of the pandemic. This would have increased total private-sector employment by 3% relative to a scenario without government assistance.

However, the researchers noted that while targeting only the businesses who needed assistance to survive would be effective, it’s difficult—if not impossible—to do in practice, as it requires much more detailed information than governments typically possess.

They next considered a scenario where governments waived firms’ monthly debt payments, which 25 of the 37 OECD countries actually implemented. They estimated that waiving financial debt expenses would have cost only about 0.3% of GDP, but would have provided only minor benefits—reducing the bankruptcy rate by 0.5 percentage points and increasing private-sector employment by 0.2%. They found that, despite the government assistance, the decline in firms’ cash flow exceeded the benefits of financial relief.

The third approach they analyzed was direct subsidies to firms: For example, the governments of France and Germany gave lump-sum transfers to small businesses. The researchers looked at the effects of a subsidy equal to a business’s pre-COVID wage bill over an eight-week span. They estimated that a direct subsidy would be quite costly—totaling about 1.8% of a country’s GDP. However, this approach would bring significant benefits: the bankruptcy rate would have declined by 5.6 percentage points, and saved jobs representing 3% of private-sector employment. In other words, direct subsidies would have reaped similar benefits to targeting only at-risk businesses, though at about three times the cost. Of course, giving all businesses support means that many businesses that would not need assistance would get it anyway: The researchers estimated that over 80% of a direct subsidy would be given to firms that would have survived without it.

“Governments face a trade-off between how targeted their support is and how costly it is,” Gourinchas said. He noted that less-targeted programs, while more expensive, might be the best that governments can do in the current state of uncertainty.

“Our paper suggests that the right kind of policy may need to be quite generous upfront, and then reclaim some of the subsidies later when the dust settles.”


*The European countries included in the study were Belgium, Czech Republic, Finland, France, Germany, Greece, Hungary, Italy, Poland, Portugal, Romania, Slovak Republic, Slovenia, Spain, and the United Kingdom.