Helping the Economy Survive Through an External Shock

Military aggressions, epidemics and natural disasters are common examples of what economists call ‘an external shock’. They are external in the sense that the reasons for the economic breakdown came from outside and were not related to how the economy had functioned before the shock. The main goal of economic policy makers in such situations should be to help the economy survive through the shock and retain as much capacity as possible. The underlying assumption is that, if viable companies and jobs survive through the crisis, the economy will be able to quickly recover after the causes of the external shock are removed.

In this article we discuss the economic survival measures taken during the COVID-19 pandemic by one of the comparatively more successful EU Member States and lessons that can be draw from this experience for dealing with the economic consequences of a much stronger ‘external shock’, that is the Russian military aggression on Ukraine.

The analogy should obviously not be taken too far. The virus did not destroy any infrastructure or buildings and its impact on logistics and human lives has been much less severe. Compared to the humanitarian disaster and destruction caused by the war, it may even seem premature to discuss the economic challenges at this very moment. This is obviously not the position of the businesses nor of the Ukrainian authorities who have already taken or announced measures to support the economy. This article hopes to contribute to these efforts by providing information on the measures taken in different but somewhat comparable circumstances. 

A good practice example

There are two reasons why Slovenia is presented as a good example. The first reason is the country’s good economic performance during the COVID-19 crisis. In 2021, Slovenia’s GDP was already 3.5% higher in real terms than before the pandemic (in 2019), with only four countries in the EU achieving a better result. At the same time, Slovenia’s unemployment rate of 4.5% is currently the seventh lowest in the EU and lower than in any country that achieved a higher economic growth. 

The cost of achieving this outstanding economic and employment performance was an increase in the public debt to GDP ratio by 14 percentage points. This roughly equals the average increase in the Euro Zone and is only 2 percentage points higher than the EU average. This shows that, in addressing a crisis, the level of spending is not as important as the measures on which it is spent.

The other reason for showcasing Slovenia is a more pragmatic one. The author of this paper was a member of the Government’s expert taskforce which designed the direction of the measures and supported their incorporation in the legal framework, and as such has a first-hand insight into the reasoning behind the measures. 

The following box gives a snapshot of key measures which are then presented in some more detail below.  

Support to the business sector

The main channel of support to the business sector was through employment retention schemes. Many companies were not able to work because of the lockdowns and others faced falling revenues due to the breakdown of supply chains and decreased demand. Normally they would adjust by laying off a considerable number of their workers. To avoid this, the government offered to fully refund the legally mandated compensation of salaries for workers who were sent on temporary leave (furlough) instead of being laid off. These workers were entitled to receive 80% of their usual pay during the temporary leave. For workers who were not sent on temporary leave but had their working hours reduced, the government paid the difference to 80% of their full salary. 

This measure thus provided income and job security for workers and at the same time a possibility for enterprises to resume their normal operations with existing staff as soon as possible – thereby avoiding the costly process of firing and rehiring. To avoid the moral hazard of companies opting for the retention scheme even when they could function normally, the government also covered pension contributions of workers who remained fully employed and mandated a lump-sum incentive top-up on their salaries. In total, roughly a third of all private sector employees benefited from the employment retention scheme.

The condition for receiving support from the employment retention scheme was that the enterprise faced a reduction of revenues by 20% on an annual basis. However, the enterprises were not obliged to provide any up-front evidence or projection proving that they met the condition. The condition was only checked at the end of the year based on annual financial statements. The enterprises that turned out to be above the threshold had to return the employment subsidy in monthly instalments during the next year. 

A special support scheme was designed for the self-employed. The self-employed persons in Slovenia make up roughly 10% of the total labour force and comprise four very different categories of people. The first category are entrepreneurs who choose the legal form of sole-proprietorship and employ other workers, for example in the construction and transport sector. The second category are persons who use the same legal form to conduct their business on their own or with the help of family members, primarily in the service sector. These two categories are like FOP (private entrepreneurs) in Ukraine. The third category are independent professionals who register their activity and an independent status but are not obliged to assume the form of sole proprietorship. Examples include cultural workers, journalists, sport professions, confessional workers and small crafts. The fourth category of self-employed are heads of agricultural households who receive their main income from agriculture.

What these remarkably diverse categories of self-employed people have in common is that they normally do not have an employment contract with themselves, although they may employ other people. This implies that their income would not be secured by the conventional employment retention scheme which covers only those who are formally employed. To address the situation of the self-employed, the government provided them with a basic income commensurate with the net minimum wage and forgave payments of social contributions during lockdowns.

The disbursement mechanism was like the employment retention scheme. The self-employed simply had to state that their income was reduced due to the pandemic and the fulfilment of this condition was checked ex-post based on their annual tax returns. In total, roughly a half of all self-employed applied for the basic income.

The main mechanism of liquidity support to businesses and the general population was a one-year loan repayment moratorium. The loan moratorium was obligatory for the banks but optional for borrowers. This meant that the borrowers, both individuals and enterprises, had the right (but not an obligation) to request a moratorium, but the banks had to accept any such request. Given the high liquidity of banks, these did not create any major distress for the financial sector. The government also provided a general state guarantee for all loans under the moratorium, so that the banks did not need to classify such loans as non-performing and create corresponding reserves.

A government guarantee scheme for new loans was also introduced but it was less effective. One likely reason was that the banks did not ease their credit-worthiness criteria despite the guarantee, and the other was that under the state aid rules the borrowers had to pay a premium for the guarantee on top of the loan’s interest rate.

In line with the loan moratorium, a moratorium on payment of rents was strongly advocated by small businesses, especially in the service sector. The government, however, considered that a rent moratorium would help the tenants but at the same time reduce the income of property owners which, to a large extent, are also private individuals and businesses. 

Given the wide coverage of employment and liquidity support, tax and cost recovery measures were scarcely implemented. There was no reduction of any tax or social contribution rates. Nevertheless, the payment of social contributions by the self-employed was forgiven during the lockdowns, as well as the payments of monthly corporate income tax advances. A one-off payment to partly cover the fixed costs of enterprises who were not able to work was introduced, but only after some sectors have had to cope with repeated lockdowns and reduced demand.

Income and demand support

Employment retention and basic income schemes provided income support for those employed and self-employed. Those not in the labour force received support through one-off top-ups on the basic social benefit and on lower-end pensions. A small income transfer was also provided to students. However, no specific support was provided to the category which is often referred to as precarious workers, i.e., those who are not formally employed or self-employed but take on occasional very short-term and low-paid jobs.

Vouchers issued to the general population were used as a demand support measure. Vouchers were first introduced to support the tourism sector which is highly dependent on foreign tourists. As the pandemic dramatically reduced their numbers, vouchers for accommodation services were issued to every citizen and tax resident of the country. The value of the voucher corresponded to the cost of two- or three-nights’ accommodation in tourist facilities. Vouchers were divisible and transferable between family members. Roughly a half of all vouchers were used, and this significantly alleviated the losses of the domestic tourism sector. The second-generation vouchers were extended to all hospitality services as well as cultural events and books. 

The regional dimension

Slovenia is a small country with a population of 2 million people. There are 212 self-government units (200 municipalities and 12 city municipalities), but no regions as political and administrative units. 

Economic support measures presented were thus designed and implemented by the central government and uniformly across the country. Still, they had some important regional effects. Tourism vouchers increased the demand for accommodations in municipalities and destinations which are outside the main holiday areas of the country and have thus helped the economy of a wide range of municipalities. The same is true of the basic income scheme, as the self-employed population is quite equally distributed across the territory of the country, i.e., they are not concentrated in only the economically strongest cities and municipalities.

The level of general budget grant to municipalities was also increased as part of the measures to address the pandemic. This was intended to recognize the higher costs of municipalities. They focused their effort on supporting provision of public services, such as education and health, but also supported local businesses, for example by forgiving the rents for publicly owned properties.

Success factors

The presentation of measures taken in Slovenia allows us to identify the following success factors behind the country’s comparatively good economic performance:

1. Broad-based measures – measures supporting economic enterprises were available to all regardless of their activity sector, size or other considerations. Income support measures covered broad groups of recipients.
2. Up-front support – beneficiaries of measures from the business sector did not need to prove their eligibility before receiving support. Following the principle of ‘help first, ask later’, eligibility criteria (in general, a reduction of revenues during the year) were checked only at the end of a year on the annual financial statements.
3. Fast implementation – the basic direction of key measures was approved and communicated within 2 weeks of the first lockdown, and the first law with economic measures was adopted by the National Assembly within a month.
4. Adaptability – the law implementing the economic measures was amended seven times within the period of a year. The main purpose of amendments was to improve the coverage of measures and to introduce more measures to address the changing circumstances. 
5. Consultations with businesses – representatives of the business sector were members of the Government’s expert taskforce. Their key role was to communicate initiatives from the business sector, evaluate proposed measures from the point of view of their effectiveness, and to insist on their administrative simplicity.

Possible applications in Ukraine

On March 19, based on the fall in receipts of taxes and social contributions, the Minister of Finance Serhii Marchenko estimated that around 30% of the Ukrainian economy was not working or was working at reduced capacity. 

The Ukrainian authorities responded to this situation with three major measures:

• Reduction of taxes and social security payments for the period of enforcement of martial law. Tax measures were adopted by the Verkhovna Rada of Ukraine on March 15 (Law 7137-d). Big companies, with some exceptions, will be included in the simplified tax regime, which effectively replaces the corporate income tax with a 2% single tax on the turnover. Individual private entrepreneurs will not pay social security contributions for themselves and their employees who have been mobilised. Owners of land located in areas where fighting is going on will be exempt from the land tax. The excise tax on petrol, heavy distillates and liquefied gas was reduced to 0, and the rate of value added tax on imports of fuel was reduced from 20% to 7%. 
• An ongoing initiative to relocate enterprises from the East of Ukraine to the comparatively safer Western municipalities. The plan is, where possible, to move the companies together with their equipment and employees. Preference will be given to strategic enterprises and enterprises that produce essential goods to meet the needs of the civilian population and the Armed Forces of Ukraine.
• Easing of loan repayment obligations. By Law 7137-d, for the period of enforcement of martial law, liability for late payment of consumer loans is lifted and there is a freeze on foreclosures and evictions due to non-payment of mortgages.

Tax reliefs are the most efficient way for immediate support to enterprises, as they can become effective at once and with little additional administrative work. However, taxes are only a part of operational costs of businesses and therefore the effectiveness of reductions in preventing lay-offs and enterprise closures is limited.

Compared to tax reliefs, employment retention schemes require more administrative work from enterprises and an efficient system of disbursement, but their effectiveness in helping the companies survive the crisis is much higher. At the same time, they provide direct income support to employees who would otherwise likely be laid-off. Preservation of jobs, to the extent possible, will also support the return of internally displaced persons and refugees to their habitual place of residence once the conditions allow. 

These arguments are not purely theoretical. In a recent survey of over 1000 Ukrainian enterprises with foreign capital, 63% said that they continued to pay full salaries to their employees – even though only 17% of all surveyed companies were still working full time and at full capacity. This shows the value that companies place on preserving the jobs and keeping the workers employed during the hardship. But obviously most will not be able to fund salaries from their own resources for long.

Employment retention schemes cost more than temporary tax reliefs. Within the EU, a special financial facility was made available during the pandemic to provide loans to Member States for financing their job preservation measures. Given that this is a known and tested approach within the EU, it is likely that a similar aid facility could be set up by the EU for Ukraine quickly. 

In general, for economic measures to be financed by foreign aid, they will need to be well structured and argued. Although any aid and support measure helps a little, it would seem advisable to focus the main efforts on a few broad-based measures. A general basic income scheme for the self-employed (FOP) who would not be covered by employment retention schemes is one possible approach. Another is a general loan repayment moratorium.

In addition to the schemes supporting payment of wages, other cost recovery measures may be needed. They could be focused on costs of relocations of enterprises and the costs of replacing equipment and structures destroyed in the war. Reconstruction may also be supported by a general corporate and income tax allowance for investment.

Demand support schemes in the form of general vouchers could have little or no impact in the current situation. However, other means of demand support could be considered. For example, if humanitarian aid is provided in cash rather than in-kind it can be used by charitable organisations to order production of goods needed to aid the civilian population from Ukrainian enterprises, thereby at the same time supporting the population and the domestic economy.

Another important consideration is the timing and duration of support measures. Regarding timing, some of the measures highlighted above could be usefully implemented even during the war. These include employment retention schemes, basic income support to FOP and loan moratorium. The duration of such measures should be extended into the time after the military conflict, as the businesses will not be able to recover and resume their normal operations very fast and without support. On the other hand, income transfers to the general population may currently be of less value than in-kind humanitarian and housing support. Similarly, investment incentives will only make sense once the reconstruction can begin.