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Garvan Walshe is a former national and international security policy adviser to the Conservative Party.

The immediate economic cost of the Covid-19 epidemic and the measures needed to contain it are starting to become clear.

Vast government borrowing. Huge numbers of people being paid not to work. The total devastation of the travel industry.

But it is also important to look at the longer-term structural effects of the disease and the measures taken against it.

These will determine the shape of the global economy for the decades to come.

The financial crisis twelve years ago has created a world of ultra-cheap money, inflated asset prices, and in the UK, an austerity programme whose effects have been felt by the young immediately, but which have had knock-on effects most visible in continuing weak productivity growth.

The rate of productivity growth is what’s known mathematically as second derivative. It is related not to the level of economic output, nor to the rate it changes (that is, growth), but to rate of change in the rate of change of output.

It is the economic equivalent of R0, the rate at which one person infected by the coronavirus infects another. It feeds though to growth, and on to the level of output.

The way countries cope with the economic effects of the epidemic will have profound effects on productivity.

Among the most important is not actually the evolution of global supply chains, which will recover from this shock and were reconfiguring anyway, or personal habits (once the shock has worn off people will want to see friends, go to conferences and explore the world as much as they ever did), but in the financing of companies.

Just as the wrong post-financial crisis policies saddled some economies with high debt-servicing costs, the wrong Coronavirus support policies will do the same for companies, and smother the creativity on which economic growth depends.

In normal economic circumstances, debt concentrates the mind.

The need to pay it back is supposed to act as a deterrent to borrowing too much, and the need to have it paid back is supposed to prevent reckless lending.

Companies that take on more debt than their revenues allow eventually go bust in the “destruction” part of creative destruction.

The important thing though is that companies’ fortunes are supposed to be contingent upon their own actions: the good ones survive and the bad ones don’t.

But Covid-19 is a global, external shock from outside the economic system. Whether your business is affected by it has a lot more to do with what overall sector it is in, than the quality of its operations.

Certain sectors where the UK is particularly strong, including high value person-to-person services like education, media production and sport have been especially hard hit by the virus.

The music industry, another area of British strength, has been pummelled.

These do not employ huge numbers of people, but they make a lot of money.

At the other end of the labour market, hotels, pubs and restaurants will be devastated.

Though furlough has taken care of their rent bill, and business rates have been drastically reduced, these businesses have ongoing obligations – mainly rent – they still have to pay.

Yet, the Government’s policies to shield businesses from the pandemic have so far chiefly taken the form of providing cash in exchange for creating further ongoing obligations – that is, debt, whether in the form of the Coronavirus Business Interruption Loans, or the Bounceback Loans for micro-businesses.

Debt is suitable for normal times, because it can be used to distinguish between successful companies, and those that need to fail.

But used against an indiscriminate shock like the Coronavirus, it risks becoming a huge weight on the private sector, discouraging innovation and reducing productivity growth even further.

Debt reduces the amount of money a business has available to invest in its own activities.

Repayments must be given priority over research and development, marketing, and even paying staff: it is far easier legally to make someone redundant than default on a debt.

We have a very flexible labour market, which promotes growth and innovation, but debt is an inflexible form of finance that does the reverse.

The usual alternative, equity, won’t quite work in this circumstances.

An equity investor takes a share in the company, and so ties themselves to its fate.

The deal is that if the company doesn’t make any profits, your share is worth nothing. The upside, of course, is that the bigger the profits are, the bigger your reward too.

This is perfectly reasonable for a private individual or venture capital fund in normal times, but unsuitable for mass government support for the economy.

Investors take a lot of time to find out about the companies they invest in, not only to work out whether to invest, but to decide how large a stake they should demand in exchange for their capital.

That is a negotiation only possible under normal market conditions.

The whole point of government support is to prevent companies driven to distress having to sell up because of the pandemic.

And anyway, no government bureaucracy is going to be able to make that kind of decision, especially for hundreds of thousands of SMEs that most need support.

Rather than ordinary debt, which will hang around the necks of businesses for years afterwards, or equity, which is impossible to price under the circumstances, the Government should create securities with income-contingent repayment.

That way companies would pay them back in proportion to the dividends they paid out, crucially, but only after they had paid their staff and invested in their own growth.

The Government could even package up these future income streams and sell them on to interested investors.

This will allow British companies to specialise in what they do best, finding what has been missed by the thorough and ponderous corporate processes favoured by German-style capitalism, and exploiting the opportunities available before they can catch up.

As the international trade expert David Henig puts it “the places we do really well are those where the rules aren’t clear.”

Government support for the economy during the coronavirus should set us up for recovery by enabling us to keep doing what we’re good at.

41 comments for: Garvan Walshe: Why the Government must convert its business Covid-19 support away from debt

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