Dealing with the Second Wave: Subsidies, Instead of Ordering Closures

Yves here. We’ve banged on about the need for income replacement if/when governments need to restrict activities to combat Covid. And Congress is still unable to agree on what the next round of stimulus should look like. Subsidies would certainly be an easier pill to swallow than yet more lockdowns and mandatory closures and would help more firms make it though the crisis. But it’s not clear the US would do something so sensible, or have the capacity to monitor compliance.

By Daniel Gros, Director of the Centre for European Policy Studies, Brussels. Originally published at VoxEU

In the autumn of 2020, many European governments are imposing ‘lockdowns light’, which usually contain limitations on the operations of restaurants, bars, and some shops considered non-essential. This column argues that pandemic control cannot be limited to lockdowns. Activities like providing restaurant meals or retailing increase the risk of infection and thus involve a large difference between private and social cost. The efficient solution to this problem would be incentives for shop and restaurant closures, rather than mandated lockdowns.

In the autumn of 2020, many European governments are imposing ‘lockdowns light’, which usually contain limitations on the operations of restaurants, bars, and some shops considered non-essential.  The assumption behind these (often partial) closures is that the risk of infections is high wherever people mingle in closed spaces.1

The mandated closures have led to strong popular protests (especially in France and Italy) because they threaten the livelihood of many small individual shop or restaurant owners.  These two sectors are already under pressure from e-commerce.  There are thus many marginal operators who feel that they cannot survive this second lockdown, even if only light.  Governments have of course been trying to provide help and compensation for lost income. But in many cases, this compensation has been late and partial, and it has proven difficult to target it at the most (economically) vulnerable.

Governments have instinctively reacted with mandated closures, but this step might not be needed if one considers the alternative of taxes or subsidies.  Taxes or subsidies have so far played no role in the so-called non-pharmaceutical interventions (NPIs), although they could achieve the same target in terms of social distancing.

In concrete terms, this could mean the following. The government could announce a subsidy to any store or restaurant owner willing to close their establishment for a certain time (e.g. 1-3 months).  A longer period of closure would be better because it would help keeping infections low for the rest of the winter.

One needs to avoid the problem of remaining stores becoming more crowded once a large proportion close. Overcrowding was already regulated prior to the new second wave restrictions as customers were asked to keep a minimum distance apart.  This type or regulation should be maintained in the simplest form possible: no more than a certain number of customers on the premises per square metre.

The government could thus start with a subsidy offer which could be specified in terms of a lump sum per square metre, paid up front to the owner of any retail establishment willing to close (for in-store shopping or dining) for a number of months.  Take-away and internet sales would still be permitted.  Each individual operator will then calculate herself the opportunities from other sales channels. For those least able to adapt, accepting the subsidy might be the best option.

In principle, it would be preferable to conduct a reverse auction under which retailers could submit the price at which they would be willing to close.  Successive rounds could then be held until the desired reduction in retail space supply has been reached. However, there might simply not be enough time to organise this now.

Applying the Lessons of Pigou and Coase

Climate change provides another example of a discrepancy between social and private interests. It has been widely recognised that a ‘Pigouvian’ tax on emissions can achieve the desired outcome more efficiently than direct regulation of polluting activities (Nordhaus 2018).  This lesson should also be applied for pandemic control.

In the case of climate change, it is widely agreed that a tax on emissions is more appropriate than a subsidy for not emitting.  In the case of pandemic control, the choice is not so clear.

Coase (1960) argues that provided transaction costs can be neglected, the efficient solution to a problem involving a difference between social and private cost should be independent of the allocation of property rights. In pandemic control, the interests of society are represented by the government, which keeps transaction costs low. The key question, then, is whether the right to keep a store open is held by the owner or whether it belongs to society.  The fact that governments provide compensation indicates that they recognise that the right to stay open should belong to the owner. It follows that a subsidy for closure would be more appropriate than a tax on restaurants.2

Political Advantages of a Closure Subsidy

In more practical terms, a closure subsidy offers a number of advantages.  It would constitute a way to provide income compensation to the most marginal businesses at a reasonable fiscal cost, while still reducing social interactions in stores and restaurants.  The subsidy for closure (of in-store activity) should be especially attractive for marginal shops or restaurants (the ones which have most reason to protest).  The subsidy would also obviate the need to make arbitrary distinctions between essential and non-essential goods.

Another, more longer-term advantage of this approach is that it would encourage small shop owners to switch to modern techniques (or quit the market).  The resistance to structural change which is so strong in this sector might then be overcome.

The remainder of column discusses some practical issues that arise in the implementation of the approach proposed here.

Practical Issues

Example 1: Restaurants

Meeting for a meal in a restaurant is widely assumed to favour infections.  Theoretically the appropriate policy action would be to reduce supply by taxing restaurants or restaurant meals (for example, by increasing VAT on restaurants).  However, this has not been politically feasible because, as argued above, the right to stay open belongs to the restaurant owner.

In Germany, the government has ordered restaurants to close for the month of November, offering them as compensation a grant equivalent to 75% of their turnover for November of the previous year.  This ‘closure’ does not affect take-aways or delivery, which remain possible.  This means that for some restaurants, turnover might actually not be that much affected by this ‘closure’ and profits might actually increase.  Other countries have followed a different approach, promising only to reimburse some ‘normal’ profit from the past.

One month is unlikely to suffice to ‘break the wave’, but it would become quite expensive to prolong the present compensation payments for much longer.  A change in approach is thus required.  One way to permit a partial lifting of the closure while keeping the fiscal and social cost under control would be to offer a subsidy for temporary closure under which the government pays restaurants a certain lump sum per square metre of indoor space (and per month) if they close.

The subsidy per month could be lower the longer the closure time. The reason for paying a lower proportion of turnover for longer closures would be that with more time to prepare, the variable costs should be higher and many marginal establishments might take this offer. Longer periods of closure (say, 3-6 months) would be preferable as it is now clear that the virus is so widely distributed that it will take months to get it back under control.

The fiscal cost of such a measure should be bearable. The restaurant sector (restaurants, bars and caterers) account for only 1% of GDP, and only about 12% of the total costs in the restaurant sector consist of rent or the cost of premises, with over 60% going to inputs and labour costs.  Even a modest subsidy should thus make it attractive for many restaurant or bar owners to close.

The same procedure could be applied to other activities for which it is desirable to reduce supply, like hotels, travel agencies, hair cutters as well as any other places with a high infection risk.

It is, of course, possible that the longer periods of closure are not needed, for example because an effective vaccine becomes available sooner than expected today.  But the government is better placed than individuals to take this risk and uncertainty justifies prudence (Eeckhoudt and Gollier 2005).

Example 2: Retail trade

Retail trade represents a particular problem at this juncture because, traditionally, a large proportion of total sales and revenues are made towards the end of the year.

Retail trade is a much bigger sector than food (and accommodation), accounting for 8-9% of employment, but only 3.5-4% of GDP.  In this respect, the differences across EU member states are small.  However, there are large differences across member states in the structure of the sector.  For example, in Italy microenterprises (fewer than ten employees) account for over 63% of total employment in the sector, versus only 25% in Germany. Small shops account thus for over 5% of total employment in Italy, versus about 2% in Germany.  In France this ratio is about 3%.  This might explain why the opposition to the new lockdowns has been so strong and widespread in France and Italy.

The other extreme, namely, large enterprises, are also important in this sector, usually accounting for about a third of total employment (and a higher proportion of value added).  The retail sector is thus characterised by a prevalence of both very small and large establishments, with many of the very small ones in a marginal position.  These marginal operators are the ones most prone to protest, but also the ones which would benefit most from a subsidy for closure, which might in many cases be permanent – thus accelerating the structural change which is unavoidable in the long run.

As for restaurants, the ‘closure’ would concern only in-store sales.  Web sales and ‘click and carry’ would still be permitted.  This should reduce the cost of ‘closure’ even for shops with some inventory, but only if they try new channels of distribution.

Speed of action seems crucial now since many retailers must be close to ordering their wares for the Christmas/end-of-year season.  Once they have placed these orders, it will difficult to keep shops closed (or expensive to induce them to close).

______

1 Since the first wave in March of 2020, most shops and restaurants have had to follow social distancing requirements (keeping customers 1.5-2 metres apart), leading to large losses for them (Miklos and Koren 2020). The epidemiological reason for trying to minimise social interactions even when this is assured is that the virus spreads apparently through aerosols, which linger longer in the air.  Some studies claim that the infection rate is 19 time higher indoors (see https://www.epa.gov/coronavirus/indoor-air-and-coronavirus-covid-19, https://www.cdc.gov/coronavirus/2019-ncov/more/scientific-brief-sars-cov-2.html, andhttps://www.ecdc.europa.eu/en/covid-19/latest-evidence/transmission).

2 Another way to justify a subsidy for closures rather than a tax is that governments should be the insurer of last resort against collective risks.  See also Aleh Tsyvinski, Nicolas Werquin (2018) and Bonardi et al. (2020).

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19 comments

  1. a different chris

    Ugh, the worst thing I swear about this pandemic is that, of all people, it brings economists to the forefront. Well maybe it will be a good thing in the long run, as it will continue to completely discredit the profession.

    It has been widely recognised that a ‘Pigouvian’ tax on emissions can achieve the desired outcome more efficiently than direct regulation of polluting activities (Nordhaus 2018).

    “Widely recognized”, sure. By people that couldn’t figure out which end of anything is up, that is.

    I’m going to tell my wife that my long-standing rule of simply not hitting her* is going to be replaced by a Pigovian tax that will require me to pay different amounts based on how hard I decide to hit her. That will go well.

    *ok, it’s because she can kick my butt so it’s in my best interests to just yell impotently, but since this is an econ post let’s imagine I am actually physically superior, kind of like that can opener…

    Reply
    1. chuck roast

      Yeah, that put the needle into me too. And using emission controls to make the point. Please, put Nordhaus back in his ivory tower. There are three general sources of air pollution: mobile, area and stationary. Area sources (e.g. blowing dust, open burning) do not lend themselves to Pigouvian measures. They are best controlled through statutes backed by penalties. Similarly, stationary sources (e.g. manufacturing plant stack, diesel generator) lend themselves to emissions monitoring and local enforcement. Mobile sources are tricky. In what appeared to be a major chronic brain cramp, the EU promoted the wide use of diesel engines in motor cars. Many pre-mature deaths later and the VW emissions defeat device scandal laid bare the “widely recognized” assertion above.

      Pardon what seems to be a minor rant on the small matter of “applying the lessons of Pigou”, but economists love to start their analysis with the old ceteris paribus assumption. This can be translated as, “And now students, let us leap through the looking glass.”

      Reply
    2. BlakeFelix

      I mean, I would take a punch for a million dollars. Pigovian taxes can be arbitrarily high. And I don’t see how fossil fuel sources are hard to track at all, tax the source, it’s hard to hide a coal mine or a fracking rig.

      Reply
    3. Susan the other

      Yes, thank you dc, I agree. I kept thinking, What in hell is this guy thinking? What a lot of frantic hair pulling. Let’s take the Siberian Grizzly – If those dudes cannot be allowed to hibernate what will happen to them? They’re apex predators and consumers – they eat anything from moths to berries to elk … and then they sleep for 6 months. (Yes, they let wolves bring down the elk, and then they muscle in, but never mind) – And if they cannot consume by a certain deadline, comparable to April 15 for us taxpayers, they’re in deep shit. Why, why, why can’t we look at ourselves as an ecosystem; as a species that has literally lost it’s habitat? Because that’s exactly what has happened to us. These twits couldn’t tie off an artery. We need a new paradigm. This analysis doesn’t look at us humans as living beings – we are nothing but robots to them. But we Are an ecosystem – Newsfuckingflash. We have an ecosystem that has collapsed. Oops. Nobody noticed? Well, too bad.

      Reply
    4. Objective Ace

      Economist here–so don’t necessarily take my indictment against this economist as an indictment against all economists

      This policy incentivizes the exact wrong behavior–overcrowding. Anyone whose taken econ 101 knows that decreasing the amount of competitors leads to monopoly type behavior. The few remaining bars open can now make even more money since their customers have nowhere else to go. And since there’s no where else to go, all bar patrons will now crowd the remaining few bars open–the exact opposite of what sound policy dictates

      Reply
    1. Keith

      I went to a UPS store in a Safeway plaza that I had not been to since at least the COVID era began. It was full and bustling, even booted out a Goodwill to make room for Harbor Freight. When I was there last week, I would say occupancy was 50/50 at best. All the closures were masked by the big names there, Safeway, Harbor Freight, ACE, etc. I don’t recall seeing any moms and pops there, although a few small chains survived. No dining survived except for a Dennys and a fast food joint (cannot remember). There were a few from places, since gone.

      Reply
  2. jef

    Lockdown is not necessarily statistically beneficial;

    “The factors that most strongly predicted the number of people who died of covid in a country were rate of obesity, average age, and level of income disparity. Each percentage point increase in the rate of obesity resulted in a 12% increase in covid deaths. Each additional average year of age in the population increased covid deaths by 10% . On the opposite end of the spectrum, each point in the direction of greater equality on the gini-coefficient (a scale used to determine how evenly resources are distributed across a population) resulted in a 12% decrease in covid deaths. All these results were statistically significant. The authors found no correlation whatsoever between severity of lockdown and number of covid deaths.”

    https://www.thelancet.com/journals/eclinm/article/PIIS2589-5370(20)30208-X/fulltext#fig0002

    Reply
    1. Synoia

      Each percentage point increase in the rate of obesity resulted in a 12% increase in covid deaths.

      Each additional average year of age in the population increased covid deaths by 10% .

      On the opposite end of the spectrum, each point in the direction of greater equality on the gini-coefficient (a scale used to determine how evenly resources are distributed across a population) resulted in a 12% decrease in covid deaths.

      With simple remedies the US, and its satellites, will not pursue. Where’s the profit in addressing the US’ largest population of elderly, obese poor in the world?

      Reply
    2. DJG

      jef: Look lower down in the article. Lockdowns help, but there has to be cooperation. People cannot invoke their right to infect others: “In the case of full lockdowns, such a government policy may only be effective in those countries where it can be easily implemented and enforced. For example, the United States has had challenges enforcing lockdowns, with citizens in several states publicly protesting public health measures to limit viral transmission, and encouraging open revolt [40].”

      The information on smoking is interesting–but may be related merely to age.

      Reply
      1. ShamanicFallout

        Yes, the “potential protective effect of smoking” has been out there almost from the beginning. But as we know, smoking is basically a taboo subject, relegated to, as it were, smoking outside, on the corner, in the cold and the rain, with all of the other ne’er do wells. It must never be broached by, or in PMC company.

        Reply
    3. Objective Ace

      Income inequality is probably a good proxy for teasing out service workers vs the work from home professional classt. I’m not sure paying bartenders, grocers, teachers, policemen more would have any effect on the death rate.

      Of course better healthcare would, but its tough to tease out exactly which underlying variable related to income disparity is at work. Surely its not actually income disparity?

      Reply
  3. Chauncey Gardiner

    The Treasury Department has about $1.6 Trillion in its account at the Federal Reserve where the money has been sitting unused for many months. Beyond deeply flawed ideology, is there some reason why at least a portion of these unused funds cannot be distributed to alleviate suffering by those among us whose employment and sources of income have been so materially disrupted due to the economic effects caused by the pandemic? I personally don’t have an iron in this fire. It just seems like the right thing to do, and a policy course with little downside but a lot of upside.

    Reply
    1. JBird4049

      It makes great sense and from distributing the first stimulus checks, most of the kinks in the system are fixed. Unfortunately, there is this group call the Congress, which don’t think that it’s necessary. At 1.6T that would be something like $9,000 per household or $4,500 for every American.

      Reply
  4. Shiloh1

    Peter Schiff podcast tonight laughing about “free 6 week government-paid vacations” and be sure that the only fools who will have to work will be in the grocery stores, electrical linemen, plumbers/HVAC, garbage men and truck drivers.

    Reply
  5. GM

    Amidst all this theorizing by economists, nobody seems to have noticed (or, alternatively, nobody dares point out) that the former Eastern Bloc countries would have had absolutely none of these problems because they had no private businesses at all. Thus they could shut down for however long is necessary to eliminate the virus, then restart normal activity without any economic destruction whatsoever, without anyone losing their home, etc.

    And in the not even that long term, all sorts of disasters (such as, but far from limited to pandemics) are inevitable…

    So what does that tell us?

    Reply
    1. BlakeFelix

      Well, they still suffer the loss of real productivity, but you are right in that they don’t do the idiotic great depression debt default / eviction /bankruptcy garbage. A UBI would be the proper response in my opinion.

      Reply
  6. TomR

    How about permanently closing HARMFUL (unhealthy) stuff, like soda or junk food sale in both shops and restaurants? A good opportunity missed…

    Reply

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