American companies laid off 22 million in the past month. Europe chose a different path

Like most British firms, Volcano Coffee Works watched, stunned, as business collapsed at the beginning of March, just as the country started social-distancing measures.

“We saw a 91% drop in our orders literally within a week,” recounts Emma Loisel, chair of the specialty coffee business. Volcano Coffee Works runs two coffee roasting sites and a café, and had, at the time of the outbreak, a fast-growing wholesale business supplying hotels, restaurants and cafes around the country. It has 31 people on payroll. 

“I feel very responsible for those people,” Loisel tells Fortune. “We’re a real family-run business where everyone has worked really hard to build what we have. And to lose that, would be a real tragedy.”

Tragedy was averted.

That’s because the government, as of today, will step in to pay most of Loisel’s wage bill. Under a U.K. government rescue plan, 80% of wages, or up to 2,500 pounds ($3,100) a month per employee, are covered for coronavirus-hit businesses in one of the most generous aid packages anywhere in the developed world.

The Brits call the measure a furlough plan. Unlike in the United States, the furloughed workers in Britain still get paid.

The hope is to keep unemployment from sky-rocketing, as is the case in the United States where a record 22 million Americans have filed for unemployment benefits in the past month, pushing the real unemployment rate in the U.S. to 17.9%, a level not seen since the Great Depression.

Without that lifeline, Loisel says, “we would have had to do mass redundancies”—lay-offs—“immediately.”

Guaranteeing payrolls

European job markets are also showing the strain of the coronavirus crisis that’s confined hundreds of millions of people to their homes and brought large sectors of the economy grinding to a halt.

But some economists say that the leap in unemployment is likely to be less severe and less prolonged in much of Europe. There’s one simple reason for that: most European governments are paying all or part of the wages of millions of private-sector workers who might otherwise have been laid off because of the slump.

The International Monetary Fund forecast last week that U.S. unemployment would rise from the 2019 rate of 3.7%—which was considerably lower than the euro zone—to 10.4% in 2020, on a par with the 19 countries using the euro currency. In 2021, it projects the U.S. will have a higher unemployment rate than the euro zone.

How bad the U.S. unemployment rate will get is still an open debate. An economist at the Federal Reserve Bank of St. Louis, Miguel Faria-e-Castro calculated in a “back-of-the-envelope” estimate that 47 million Americans could be laid off, sending unemployment soaring to 32% in the second quarter.

Faria-e-Castro did not take into account the effects of the various government bailout measures to mitigate job losses, but when you see the steady flow of job-cuts headlines from the airlines, retailers like Macy’s and hotel and casino operators, Marriott and MGM, it becomes hard to call a floor on the number of Americans soon to be out of a job.

In much of Europe, the aim has been to keep staff on payrolls as long as possible, even if ultimately governments—in essence, taxpayers—pick up the tab. Economists at Germany’s Berenberg bank say that by encouraging firms to hang on to their workers during the crisis, Europe is making it more likely that business can quickly get back to normal once the restrictions are lifted, and factories, offices, schools and restaurants re-open. The European approach also limits the risk of high unemployment turning a short-term shock into a longer slump, they say.

“In many ways, the U.S., with its entrepreneurial spirit and rough and tumble dynamic markets, is a role model for the less flexible parts of Europe. But on the specific problem of containing mass dismissals during a crisis, the U.S. could take a leaf out of Europe’s book,” Berenberg economists wrote in a recent investor note.

The German word for jobs subsidies

The prototype for the European schemes is Germany’s “kurzarbeit” subsidy for reduced working hours. This tool was credited with cushioning the impact of the 2008-09 financial crisis in Germany. Back then, Berenberg notes, Europe’s biggest economy lost proportionally far fewer jobs than the United States and employment recovered to pre-crisis levels in Germany several years before it did so in the United States.

This time around, many European countries have adopted similar schemes to the German model, including France, Italy, the Netherlands, Spain, Britain and Denmark.

An employee wearing a protective face mask removes a cordon next to an Opel Astra at a showroom in Ruesselsheim, Germany, on Monday, April 20, 2020. Germany shut businesses and factories over the past month, but a government scheme to pay a portion of wages kept layoffs to a minimum. Wire photography: Alex Kraus—Bloomberg via Getty Images
Alex Kraus—Bloomberg/Getty Images

The details vary from country to country. In Germany, the government will pay employers affected by the crisis up to 67% of workers’ net salaries. In France, the state will pay 84% of net salary, with 100% for those on the minimum wage, while under Italy’s Cassa integrazione guadagni scheme, the state will pay 80% of wages for up to nine weeks.

Short-time working schemes, as they’re called, allow firms to hang on to skilled workers, avoiding the costs and delays of retraining new ones when business picks up. But the float-all-boats policy has its foes.

A good investment?

The biggest criticism is that it can create economic distortions by keeping inefficient firms on life support or by retaining workers in a declining sector, such as bricks-and-mortar retail, when resources might better be shifted to more dynamic industries.

Having government step in to pick up the pay checks of private-sector workers seems to conflict with U.S. free market ethos of flexible labor markets, which tend to shed jobs quickly in a downturn and strongly increase them in a boom.

But other economists say that the differences between the U.S. and European approaches to labor shocks during coronavirus are not as great as they seem.

“I guess the general narrative is that the U.S. is doing a lot less in terms of trying to keep people in jobs and that’s been reinforced by the unprecedented wave of jobless claims we’ve had over the past few weeks. I think in reality though, the general picture is the U.S. is still doing quite a lot. It’s just that it is targeted in a different way to a lot of these European countries,” Andrew Hunter, senior U.S. economist at Capital Economics, told Fortune.

The U.S. approach

The U.S. Paycheck Protection Program, which provides $350 billion of small business loans, forgivable if firms keep workers on the payroll, is “essentially pretty similar” to the European schemes although the steps firms had to go through were slightly more complicated, he said.

“The other key aspect of the U.S. response is the big expansion of unemployment insurance,” he said, noting that the $2.2 trillion CARES Act offers more generous unemployment benefits, and to more portions of the labor market—including part-time and gig economy workers.

Nicholas Economides, economics professor at New York University’s Stern School of Business, said when it comes to policies directed at the labor market, size matters.

In the U.S., the stimulus package was about 10% of GDP and there was a discussion about increasing it “while in the euro zone they’ve talked about 500 billion euros which is less than 5% of the GDP of the euro zone. I think that would be totally inadequate,” he told Fortune.

In the best-case scenario, many Americans claiming unemployment benefits would go back to their former jobs, or find new ones, when the lockdown ends. But that depends on how long they are unemployed, says Economides.

“If we are talking about a month, two months or two-and-a-half months, I think it is very likely that the vast majority are going to go back to their work … but if we are talking about three months or longer, we don’t know,” he said. “I think it will take time for employment to come back to previous levels.”

Strong take-up

So far, take-up of the European short-time working schemes has been strong, Capital Economics said, noting that 4 million workers were covered by the scheme in France, while an estimated 620,000 companies covering almost 3 million workers have already applied for the Spanish scheme.

But its success comes at a cost. Highly indebted European governments will have difficulty extending the programs should the downturn last several months. For that reason, fiscal hawks are paying close attention to who applies. Liverpool F.C., the European champions, backed out of the program after the move drew strong criticism from fans.

The U.K. government’s furlough payment went live on Monday, a relief for Loisel, of Volcano Coffee Works. A delay of even a few days would have meant the company covering another payroll cycle.

“It’s not that we don’t think it’s coming,” she said last week before the government confirmed the start date. “It’s just the reality of timing of cashflow that this is making it much harder for small and medium businesses to plan, and to manage their way through this.”

For anyone who’s had to deal with payroll, the task can be daunting. Try doing it for an entire country.

More must-read finance coverage from Fortune:

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—Couldn’t track your stimulus check? Errors and long waits plague IRS portal rollout
—What the government bailout means for airline investors (and CEOs)
—How every sector of the S&P 500 has been impacted by the coronavirus selloff
—How Fortune 500 companies are utilizing their resources and expertise during the pandemic
—Listen to Leadership Next, a Fortune podcast examining the evolving role of CEO
—VIDEO: 401(k) withdrawal penalties waived for anyone hurt by COVID-19

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