State equity support runs risk of moral hazard

State equity support runs risk of moral hazard

One of the arguments deployed by advocates of the EU’s landmark €750bn recovery package agreed last week was that some governments, particularly in Europe’s highly indebted south, had less fiscal leeway to support their businesses and workers than others. This could create severe competitive distortions in the single market and accentuate economic divergence in the eurozone, imperilling the stability of the single currency.

“We need to make sure that we protect the functioning of the internal market,” Spain’s finance minister Nadia Calviño told the FT in April. “It cannot be that some countries are able to support their economies in a more generous manner than others.”

Early responses to the pandemic supported the contention. Liquidity support to businesses and in some cases direct government purchases of corporate bonds account for the majority of public aid in all of Europe’s big economies. By late March Germany had earmarked a whopping €756bn in credit guarantees for its companies, nearly eight times as much as Spain or Italy, although they have since doubled their commitments. 

In May, the European Commission said Germany alone accounted for just over half of overall state aid in the EU. German government support for air carrier Lufthansa is nine times larger than Spain’s for International Consolidated Airlines Group, although that might reflect the relative financial strengths of the companies.

Yet Spain and Italy are expected to suffer economic contractions of 11 per cent this year, the worst in the EU. German GDP on the other hand will shrink by a less eye-popping 6 per cent. The case for EU solidarity could not be stronger. It is why Berlin swung behind the need for a big EU recovery fund, much of it paid out in grants.

However, research by the Bruegel think-tank and the Peterson Institute for International Economics suggests that “contrary to widespread concerns, firms in richer or less-indebted countries do not appear to disproportionately benefit from these schemes”.

The researchers — Julia Anderson, Francesco Papadia and Nicolas Véron — tallied the amounts each of Europe’s big economies had actually committed by the end of June. In Germany, it was only €36bn. In Italy it was €51bn, Spain, €85bn and France €108bn. 

The discrepancy is hard to explain, say the authors. “It is notoriously difficult to disentangle the respective roles of supply of, and demand for, bank credit in driving lending volumes, especially in times of turmoil like at present.” One possibility is that much of the support in Germany has come from its Kurzarbeit short-time work scheme, the gold standard of job subsidies. But France’s has been more generous and more extensive. 

“It may be that the conditions of loans [in Germany] are less attractive,” said Mr Véron. “It may be that German companies have less need of it, given their financial profile and the structure of the economy. It may be that the economic shock is not as big.”

All in all, the loan guarantee schemes have spurred new lending to non-financial corporations, do not appear to depend on whether governments are highly indebted or not and have not distorted the EU internal market. But if liquidity support has been a great success, equity support could be altogether more contentious.

Germany has assembled a €100bn war chest for equity injections via its Economic Stabilisation Fund. So far, across the EU, there have been only a handful of state-funded recapitalisations notified to Brussels. The biggest by far is Berlin’s €6bn bailout of Lufthansa and it is being challenged by rival carrier Ryanair. 

There are likely to be a lot more later in the year as other forms of government support such as job subsidies are tapered or withdrawn and companies have difficulties repaying their debts. The European Commission has set rules on recapitalisations to try to limit the impact on competition. But drawing up a framework for taking stakes in strategically or economically important companies is going to be hard to do and will run into big moral hazard issues.

A proposal for a €31bn EU “solvency support instrument” to take equity stakes in European companies was ditched in last week’s fraught recovery fund negotiations. Scrapping the idea made for easy cost-saving. But it would have been fiendishly hard for 27 governments to agree on how to use such a fund. So now it will fall solely to individual governments to take stakes in their companies and some will be a lot happier taking on the risks than others.