Lockdown, employment adjustment, and financial frictions

We examine firms' employment adjustments immediately after the imposition of stringent lockdown in March 2020. In doing so, we use monthly administrative data, and take value-added tax payment changes as a proxy for the demand shock. We merge data with COVID-19 tests, classified by economic activity, and employ a fixed effects instrumental variable regression. We find that all sized firms in the manufacturing sector reduced employment more if they had uncovered tax liabilities before the lockdown. Among small firms, real estate and service sector firms downsized more rapidly. While employment changes are rather modest, this very early evidence points to the need to address liquidity needs and firm pre-conditions among capital-intensive and services firms and, in particular, small businesses, to avoid employment losses. Plain English Summary The administrative data from the first COVID-19 lockdown in 2020 point to the need to address liquidity requirements among manufacturers, capital-intensive and service firms, and, in particular, small businesses to avoid subsequent employment losses. While there is a vast literature on firms' adaptation and adjustments in the face of adverse shocks, firms' reactions and the macroeconomic implications of stringent, government-imposed lockdowns are much less understood due to their novelty. We analyze businesses' responses to the first and very stringent lockdown in March 2020 by making use of monthly administrative data and taking value-added tax payment changes as a proxy for the demand shock. We exploit variation in the sectoral differences across small, medium, and large firms. A simple average employment adjustment was non-negative in agriculture, construction, information and communication, and public administration sectors in our sample. By merging data with COVID-19 tests, classified by economic activity, and employing a fixed-effects instrumental variable regression, we find that all sized firms in the manufacturing sector reduced employment more if they had uncovered tax liabilities before the lockdown. Among small firms, real estate and service sector firms downsized more rapidly. While employment changes are rather modest, this very early evidence about businesses' reactions to COVID-19-induced uncertainty and activity restrictions points to the need to address business liquidity needs early on. Another policy message concerns the importance of firm pre-conditions among capital-intensive and services firms and, in particular, small businesses to avoid subsequent employment losses.