The hidden drawbacks of loan guarantee programs for small businesses

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Loan guarantee programs are designed to help small businesses access credit during financial crises, especially during recessions.

These programs aim to keep the economy moving by ensuring that small and medium-sized enterprises (SMEs) can still get loans when banks might otherwise be reluctant to lend.

However, a recent study reveals that these programs can have unintended negative effects on the labor market.

The study, “The Labor Market Effects of Loan Guarantee Programs,” was co-written by Jean-Noel Barrot (HEC Paris), Thorsten Martin, Julien Sauvagnat (Bocconi University, Milan), and Boris Vallee (Harvard Business School).

It was published in the SSRN Electronic Journal.

The researchers used detailed data on French SMEs that benefited from public loan guarantee programs by Bpifrance, a public investment bank, during the 2008–2009 financial crisis.

They looked at how the intensity of these programs varied across different regions and used this variation to estimate the programs’ impact on employment and wages.

The findings were somewhat mixed. On the positive side, the loan guarantee program significantly boosted employment and wages in the companies that received the guarantees, leading to overall job growth and a decrease in unemployment benefits up until 2015.

This shows that the program was successful in its primary goal of preserving jobs during tough economic times.

However, the study also uncovered some less favorable effects. One major downside was that the program reduced worker mobility. Highly skilled workers, who are usually in high demand and often move to more productive companies during a recession, were less likely to do so.

This lack of movement, known as labor misallocation, meant that these workers stayed in less productive firms instead of moving to where they could contribute more effectively to the economy.

This reduced mobility led to a decrease in overall productivity, affecting the economy’s recovery trajectory after the recession. Essentially, while the program helped keep people employed in the short term, it also prevented the labor market from naturally adjusting and reallocating workers to where they were needed most in the long term.

The researchers conducted a cost-benefit analysis of the loan guarantee program and found that it did bring positive revenue for the government and savings on unemployment benefits, with an estimated 270,000 jobs saved. Despite these benefits, the negative impact on labor mobility and productivity cannot be ignored.

The authors suggest that while loan guarantee programs can be effective in preserving jobs during economic downturns, policymakers need to consider ways to support not just job retention but also labor mobility. This could help improve overall productivity and economic growth. Striking a balance between these goals is crucial for achieving sustainable economic outcomes.

In summary, loan guarantee programs can be a valuable tool during financial crises, especially in regions with high unemployment and flexible workforces. However, it’s important to design these programs carefully to avoid long-term negative impacts on labor market efficiency and productivity.