Does the economics of the government’s coronavirus job furlough scheme make sense?

Does the coronavirus Job Retention Scheme create bad incentives for firms and workers? Is it too expensive? What reforms should the government be looking at? Ben Chu assesses the evidence

Wednesday 06 May 2020 16:07
The Chancellor is set to issue an update on the policy next week
The Chancellor is set to issue an update on the policy next week

The government’s coronavirus Job Retention Scheme has, on the face of it, been a stand out success.

So far, according to HMRC, some 800,000 businesses have successfully tapped the new subsidy programme, putting 6.3 million of their employees, around a fifth of the entire UK labour force, on furlough.

It’s reasonable to assume that in the absence of the scheme a large proportion of those employees would have been made redundant and the wave of joblessness currently breaking over the UK would have been significantly greater.

Yet there are also now noises coming out of the Treasury suggesting that the scheme might, in some respects, have been too successful – that so many companies have accessed the support that withdrawing it could prove agonisingly difficult. The chancellor, Rishi Sunak, has also raised concerns over the spiralling cost of the support to the public purse.

Are such fears warranted? And with the chancellor due to issue an update on the policy next week, what should the government’s next steps be when it comes to supporting both workers and firms through this crisis?

The costs and the benefits

In an interview with ITV News on Monday Mr Sunak said the furlough scheme – whereby the state picks up 80 per cent of the cost of an employees wages up to a ceiling of £2,500 a month – was potentially as expensive as funding the NHS.

“That is not a sustainable situation,” he said.

The estimated cost of the support extended so far is around £8bn. The scheme is currently due to expire on 30 June, but there is no cap on the number of firms who can tap it in that time. The Office for Budget Responsibility put out a scenario last month that had the scheme costing £42bn over three months.


The cost of running the health service for three months is around £45bn, which is the likely basis for the chancellor’s comparison.

Yet it’s a mistake to view the job subsidy as a pure public cost.

If those millions of workers were unemployed instead of furloughed that would entail a much higher state welfare bill, via unemployment and other benefits.

And the fact that the scheme keeps workers linked to their employers – meaning they can be put back to work rapidly when the crisis is over – should also, theoretically, be more economically efficient than redundancies and attempted re-hirings.

Avoiding the cliff-edge

Business lobby groups have raised the alarm over a potential wave of redundancies when the scheme ends.

The problem for many businesses is that they do not know what the state of demand for their goods and services will be in two months’ time.

Many suspect that it will not be as strong as it was prior to the lockdowns. If that’s the case they may feel they need to reduce their workforce. Yet there’s a legal consultation period for making redundancies of between 30 to 45 days.


If the support ended suddenly at the end of June that would mean they would have to start making redundancies very soon if they wanted to have downsized their workforce by the time of the economy re-opening.

Lobby groups say the government should remove this cliff edge facing firms by committing now to extend the scheme past June and allowing some workers to return on a part-time basis.

There’s some discussion of the government tapering down financial support rather than removing it all at a stroke, such as by covering a smaller share of an employee’s wages.

This, of course, would have financial implications for the Treasury.

An incentive problem

Some around Mr Sunak have, apparently, suggested that companies are in danger of becoming “addicted” to the scheme.

And one of his predecessors, Norman Lamont, has argued that it might provide a “false sense of security” for people because their jobs are not likely to return after the scheme ends – that furlough is merely delaying the inevitable.

Economists says the addiction analogy is inaccurate and most strongly support the broad principles of the scheme.


Yet there is a concern about some of the incentives created by the scheme, such as the effective pressure on companies to furlough employees entirely to access the subsidy, rather than to merely reduce their hours.

It could also conceivably discourage firms from re-opening as early as they otherwise would.

The furlough scheme is also likely to prevent some workers from searching for work elsewhere, even when this might be in their own long-term interests.

At a time when the economy is still in lockdown this might not represent a major economic problem. But as hiring picks up it could become one.

The trade-off facing policymakers is in extending the support to protect certain firms and allowing the normal, broad, employment market incentives to operate.

The balancing act

The Institute for Fiscal Studies says the government should try to identify sectors where many furloughed employees are less likely to return to work as normal – citing hotels and restaurants – and act to reduce barriers to these individuals taking alternative work.

Mike Brewer of the Resolution Foundation, the think tank that originally proposed the furlough scheme, says that it was the right policy at the time it was introduced, but agrees that it needs adjusting for the next phase of the crisis.

“What we need is a scheme that encourages and allows employers to adjust, encourages and allows work to happen where it can do so safely and tries to avoid millions of families seeing a huge income hit,” he says.

“Doing all those is really, really hard.”

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