Labor Market Effects of Public Bank Guarantees

Public bank guarantees are widespread across the globe. There has been growing evidence with regards to its effect on risk taking incentives of banks and its countercyclical benefits during a credit crunch. Although real effects of financing constraints have received particular attention over the past years, little is known about the long-term effects of public bank guarantees on labor market outcomes. The 2008 financial crisis and the following recession underscored the role of financing constraints on firm demand and the labor market overall. Recent papers suggest that firms that are hit by a financial shock through their lending institution experience a reduction in employment, in the number of hours worked, and in wages. This observation justifies the role of government induced countercyclical lending and its effect on local labor markets. On the other hand, government interventions on bank lending may hinder creative reallocation/cleansing in the real economy. We plan to study the effects of public bank guarantees on employment outcomes. We address whether the distortions to banks’ credit decisions induced by bank guarantees have an impact on the allocation of labor from the perspective of firm turnover, employment turnover, and job transitions. Bank guarantees are argued to reduce market discipline on banks and their incentives to screen and monitor firms for credit decisions. Through this channel, unproductive firms receive funding which delay the otherwise optimal exit decisions. This mechanism also distorts the efficiency of firm hiring and firing decisions leading to an unproductive employer-employee matching. We plan to investigate whether lack of screening due to bank guarantees induce adverse outcomes in individuals and firms’ labor market turnover. For this we rely on the 2001 decision of European Court of Justice that removed public bank guarantees in Germany as a quasi-natural experiment. This change affected only German public banks as they were protected by a federal government guarantee, while the rest of the banks can be used as a control group. We first plan to develop a theoretical model of labor market with credit constraints, which provides hypotheses about the role of banks' screening decision on allocation of labor. We plan to test the implications of our theory in three steps. First, we investigate whether unproductive firms with higher savings banks dependence prior to the court rule in 2001, experience a change in the exit dynamics after the policy change. Second, we check whether unproductive firms that are more prone to funding through savings banks prior to 2001, experience a change in employment, new job matches, and job separations. Third, we check whether individuals who work in unproductive firms that rely on considerable funding via savings banks prior to 2001, experience faster job separation or job changes after 2001.