REAL ECONOMY BLOG | January 23, 2023


This is the first article in a series this week examining major economic policy responses to the pandemic that targeted small and midsize businesses. The second article will look at the Main Street Lending Program, and the third will offer policy recommendations for responding to future crises.

Economic policies put in place to address the pandemic will go down in history alongside those of the Great Depression and the global financial crisis as some of the most controversial and effective government responses ever implemented during a crisis.

A major lesson from the pandemic is that governments must act quickly and forcefully and stick with it.

The American economy was facing an abyss in March 2020 as millions lost their jobs and the economy came to a virtual halt, but because of forceful action by the fiscal and monetary authorities, it rebounded faster than expected.

A major lesson from the response is that governments must quickly overwhelm the problem through the financial channel and then be willing to sustain such efforts longer than many might be comfortable with. These efforts must be taken with the understanding that unintended consequences like inflation might have to be directly and painfully addressed in the aftermath of the crisis.

With the pandemic-era economy now likely history, we felt it appropriate to take a look at the impact and efficacy of pandemic-era policies on the small and medium enterprises.

Three years ago, as the pandemic took hold, governments around the world aggressively put forward fiscal assistance—in many cases equal to or greater than 20% of gross domestic product—to prevent a systemic crisis from causing a depression.

The response spelled an end of the so-called neo-liberalism of economic thought that engendered five decades of government non-involvement in Western economic activity.

GDP comparisons

By abandoning long-held reservations about interventions into their economies, governments in effect became the employer of last resort, providing emergency lending to businesses and subsidizing business payrolls.

In the United States, an administration and legislature dominated by proponents of austerity quickly did an about-face. They approved the Paycheck Protection Program to maintain employee wages and the Main Street Lending Program to provide liquidity in the commercial and industrial lending market that would keep middle-market businesses afloat.

Nearly three years on, what can we say about the effectiveness of those programs?

Pandemic emergency funding

In our estimation, these programs provided the necessary bridge financing to avoid what would have otherwise been a much greater economic catastrophe.

We can extract critical policy lessons from each program. For one, it would be wise for the political authority to set aside permanent funding to ensure that federal agencies are ready to act quickly in the event of another outbreak or exogenous shock.

Paycheck Protection Program

A restaurant owner in New Jersey had a succinct reply when asked about the role that the Paycheck Protection Program played in his business: “I wouldn’t be here!” he told RSM. Indeed, his bank account was down to his last $3,000 before the second PPP installment arrived, he said.

The Paycheck Protection Program had a clear impact on preserving jobs, but the cost was steep.

Through the PPP, he was able to keep a skeleton crew of long-time employees on the payroll during the COVID-19 crisis. And it allowed the restaurant to scrape by on takeout orders until warm weather arrived and customers could dine and drink outside.

Still, it became evident among the restaurant community that PPP money was not being distributed equally and was not helping the smaller establishments that needed it the most. Analysis at the Federal Reserve Banks of St. Louis and Boston confirmed those perceptions.

The PPP program was run under the authority of the Small Business Administration, with loans made by lending institutions and then guaranteed by the SBA.

William R. Emmons and Drew Dahl of the St. Louis Fed found that, to policymakers’ credit, the program was implemented quickly, only three weeks after declaration of a national emergency. It provided billions of dollars to maintain payrolls, to hire back employees and to cover important overhead. And it wrapped up most of its operations within two years, with more than 90% of the nearly $800 billion of PPP loans forgiven as of June 2022.

The program had a clear impact on preserving jobs. Research by the economist David Autor and others at the Massachusetts Institute of Technology estimated that taking out a PPP loan boosted firm employment by between 4% and 10% in May 2020 and by 0% to 6% by the end of the year.

But the cost was steep. The authors estimate that the program cumulatively preserved between 2 million and 3 million job-years of employment over 14 months at a cost of $169,000 to $258,000 per job-year.

That implies that only 23% to 34% of PPP dollars went directly to workers who would otherwise have lost jobs. The balance flowed to business owners and shareholders, including creditors and suppliers of PPP-receiving firms.

But the PPP was a government-guaranteed loan and grant program to small and medium-sized businesses, with the goal of preserving jobs at those firms.

An analysis by Gustavo Joaquim and J. Christina Wang at the Boston Fed looked at the effects of the program. Its first stage ran from April 3 through Aug. 8, 2020, with more than 5 million loans amounting to just over $525 billion. In the end, the program disbursed roughly $800 billion in loans.

Only small businesses with 500 or fewer employees were eligible for the program. The loans were fully guaranteed by the government, and the maximum loan amount was 2.5 times a firm’s average monthly payroll costs in the preceding year, up to $10 million.

Firms could apply for a second PPP installment if it met several conditions: that the firm had spent all of its first-round loan only on authorized expenses, that it had no more than 300 employees, and that it could demonstrate at least a 25% reduction in gross receipts between comparable quarters in 2019 and 2020. The maximum loan size for a second-round PPP loan was $2 million.

PPP loans did not require collateral or personal guarantees and would be fully forgiven if funds were spent in accordance with the rules, such as those on permitted expenses (chiefly payroll) and on maintaining employment levels.

Joaquim and Wang found that more creditworthy firms were more likely to receive a PPP loan and to receive it earlier. In addition, firms that received loans in the earliest stages of the program were less risky (in terms of credit scores) than those receiving loans at later stages.

Finally, firms that received any PPP assistance were less risky than those that did not. Overall, a PPP loan significantly improved the recipient firm’s financial condition, leading to an 18% reduction in credit risk on average, Joaquim and Wang found.

The authors also said that later loan recipients exhibited greater financial improvement compared with earlier recipients within the same state, industry, age group and size group and even more so if the comparison was restricted to firms with the same pre-COVID financial and commercial viability. In our opinion, this confirms that firms that were last in line for relief were the ones that needed it most.

Could PPP have been better?

The St. Louis Fed authors found PPP to be a “critical but imperfect policy.”

The MIT authors concluded that PPP was essentially untargeted because the United States lacked the administrative infrastructure to do otherwise. Other high-income countries with modern administrative systems were better able to target pandemic business aid to firms in financial distress.

The MIT authors continued that only about a quarter of PPP funds supported jobs that would have disappeared otherwise. In addition, the PPP’s benefits flowed disproportionately to wealthier households rather than to the rank-and-file workers.

Other crisis programs, including unemployment insurance and economic impact payments, were targeted much more successfully to wage earners.

They conclude that building similar administrative capacity in the United States would enable improved targeting when the next pandemic or other large-scale economic emergency inevitably arises.

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This article was written by Joseph Brusuelas and originally appeared on 2023-01-23.
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