Furlough scheme may have triggered financial distress

As the Job Retention Scheme (Furlough) is coming to an end in the UK, a paper published by the University of Birmingham concluded the government-designed scheme preserves a worker’s job during the COVID-19 pandemic but it provokes substantial decline of their monthly income that may trigger financial distress.

Research led by Christoph Görtz, Danny McGowan and Mallory Yeromonahos of the Birmingham Business School used household survey data from the Understanding Society Database provided first-hand evidence on whether the UK furlough scheme has been designed effectively and whether it prevented household financial distress during the Covid-19 pandemic.

The paper concluded an individual is 30% more likely to be late on housing payments and 9% more likely to be late on bill payments, relative to a non-furloughed individual.

While the furlough scheme is effective in preventing mass unemployment and retains employer-employee relationships, the furlough-induced adjustments in households’ savings potentially increase wealth inequality as workers exit furlough with lower savings relative to non-furloughed individuals.

Moreover, the increase in financial distress during furlough is concentrated among workers earning low pre-pandemic incomes and with lower educational attainment.

Since March 2020 the government pays 80% of wages up to a maximum of £2,500. These contributions have been gradually reduced recently until the Coronavirus Job Retention Scheme comes to an end in September 2021.

The paper highlights that while furloughed individuals significantly had their expenditure reduced they had spent their savings to offset furlough-induced income reductions which then created further wealth inequality. These changes in spending patterns persisted even after the furlough spell has ended and the individual is back in regular employment.

This is important as 24% of the workforce have been furloughed in the UK at least once as governments across the world have introduced Short-Time-Work (furlough) schemes to mitigate the economic damage of COVID-19 aimed to safeguard jobs and incomes by allowing employers that are adversely affected by the pandemic to place workers on temporary leave rather than make them redundant.

During a furlough spell, the government pays part of a worker’s wages up to a maximum amount, and while in some countries employers have discretion to pay the remaining salary, many choose not to. Although furlough schemes have been effective in preventing mass unemployment, the reduction in income during a furlough spell can imply substantial financial difficulties for many households.

At the same time, furlough schemes place heavy burdens on public finances. It is therefore crucial that they are effective in preventing widespread household default while remaining financially sustainable. The paper finds that the 80% government contribution to furloughed workers’ wages minimises the incidence of household financial distress at the lowest cost to taxpayers.

Dr Christoph Gortz, co-author and Associate Professor in Macroeconomics at the University of Birmingham says: “The UK Coronavirus Job Retention Scheme comes to an end in September 2021. Since the pandemic is not yet over, it is important to take stock and learn lessons about the effects and effectiveness of this policy.

“While being furloughed implied financial hardship and cutbacks for many families, on average, we find that the UK furlough scheme is well designed in the sense that the government contribution to furloughed workers’ wages minimizes the incidence of financial distress at the lowest cost to taxpayers.”

Professor Danny McGowan, another co-author of the study says: “While furlough was certainly a distressing experience for some individuals, the overall effect on the number of households in financial distress due to the Coronavirus Job Retention scheme was small.”

While the furlough scheme was initially due to run until June 30, 2020, the government made clear from the start it could be extended should the pandemic endure. After several extensions, from June 10, 2021, the furlough scheme was effectively closed to employees who had not been previously furloughed.

The government reduced its contribution to 70% and mandated employers contribute at least 10%, of a worker’s monthly wage from July 1, 2021.

From August 1, 2021, the government further reduced its contribution to 60%, with employers paying at least 20%, of furloughed workers’ monthly wages.

Since July 1, 2021, employers must pay the National Insurance and pension contributions that were previously paid by the government.

The sample period spans April, 2020, to April, 2021. It therefore covers almost the entire time during which employees could be newly registered to participate in the furlough scheme, but it does not include the period of reduced government contributions.

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