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Beyond BLS

Beyond BLS briefly summarizes articles, reports, working papers, and other works published outside BLS on broad topics of interest to MLR readers.

October 2024

Effects of postdisaster recovery loans on the economic outcomes of firms

Summary written by: Yavor Ivanchev

In the aftermath of natural disasters such as hurricanes or pandemics, small businesses in affected areas often experience a sharp liquidity crunch that endangers their survival. To meet this urgent demand for cash, governments have typically provided recovery assistance in the form of grants (money that does not have to be repaid) or, in some cases, direct loans to firms struggling with repairs or other emergency needs. Critics of the latter approach have argued that government recovery loans are ineffective, either because they waste taxpayer money on already-distressed businesses with little repayment ability or because they crowd out private lending.

In an article titled “After the storm: how emergency liquidity helps small businesses following natural disasters” (National Bureau of Economic Research, Working Paper 32326, April 2024), Benjamin L. Collier, Sabrina T. Howell, and Lea Rendell probe the arguments of the critics by examining the postdisaster real and financial outcomes of businesses applying for government recovery loans. The authors’ analysis estimates the causal effect of these loans by using discontinuities in the loan approval process, covering the period from 2005 to 2017. The analysis is based on loan application and approval data from the Small Business Administration disaster recovery loan program, which provides low-interest, long-maturity loans to affected businesses. Economic outcomes (e.g., firm closures, employment, and earnings) are assessed with data from the U.S. Census Bureau and credit-bureau data from Experian.

The results reported in the article run counter to the claims of those skeptical of government recovery lending. The authors find that such lending sharply alleviates business financial distress, reducing the odds of both firm exit (by 13 percentage points) and bankruptcy (by about 4 percentage points), with those effects persisting for several years after a disaster. Interestingly, rather than crowding out private lending, government recovery loans attract it, producing a multiyear crowd-in effect that boosts the number of firm contracts with private lenders and stimulates local investment. With respect to labor outcomes, the authors find that government recovery loans cause a substantial increase in firm employment (18 percent), especially among employer firms (those hiring paid workers beyond the firm’s owners), and reduce the likelihood that an employer firm would transition to a nonemployer firm (a firm with no paid employees other than the owners). These loans are also found to have a positive effect on the earnings of employer firms. In short, government recovery loans appear to reduce business financial distress, attract private lending, spill over in the local economy, and boost firm employment and revenue.

In trying to explain these positive effects, the authors conjecture that government lending may remove two possible sources of market friction: preexisting financial constraints (e.g., those that may stem from a firm being younger or burdened by a low credit score) and lending risks associated with postdisaster repairs. The authors’ analysis rules out the former possibility, indicating that the outcomes of firms that are potentially financially distressed are not substantially different from those of other firms. Instead, the evidence suggests that government loans reduce initial risks and uncertainty associated with financing repair and recovery operations, thus removing a constraint on subsequent private lending and investment.