NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Conference on Entrepreneurship and Economic Growth

Supported by the Ewing Marion Kauffman Foundation
Manuel Adelino and David T. Robinson, Organizers
October 14-15, 2016


Can Paying Firms Quicker Affect Aggregate Employment?

Governments around the world are major consumers of goods and services produced by private sector firms. In the U.S., federal government procurement amounts to 4 percent of GDP and includes $100 billion in goods and services purchased directly from small businesses. Typical contracts between firms and the government — as with most buyers and sellers — only require payment one to two months following the approval of an invoice, while payroll is usually made weekly or bimonthly. Small businesses contractors therefore effectively lend to the government while simultaneously having to borrow from banks to finance their payroll and working capital.

More generally, such inter-firm lending, also known as trade credit, is three times as large as bank loans and 15 times as large as commercial paper in the U.S. Trade credit claims, recorded as accounts receivable on firms' balance sheets, are typically seen as short-term, liquid, low-risk claims that should be very easy to pledge, and that should not constrain firm growth. Yet recent research has found that long payment terms force financially constrained firms to cut back investment and expose them to liquidity risk.

Jean-Noel Barrot and Ramana Nanda investigate the labor market consequences of accelerated payments to small businesses by examining whether paying small business contractors faster can have a meaningful effect on their cash flows, facilitate hiring, and ultimately stimulate aggregate employment. To the extent that this is an effective way to alleviate financing constraints, it enables government to directly impact the cash flows of small businesses, as opposed to indirectly targeting small firms through the regulation of commercial banks or through loan guarantee programs.


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The researchers study the impact of the federal Quickpay reform on firms' employment. The reform, announced in September 2011 by President Obama, accelerated payments to a subset of small business contractors of the U.S. federal government, reducing the time taken between invoice approval and payment by 15 days. Annual contract value of $64 billion was accelerated and impacted a set of small businesses across virtually every U.S. county due to the massive footprint of federal government procurement. Despite being extensive in coverage, the reform was focused on firms that were small business contractors to the federal government who were not already being paid in 15 days. Moreover, since payment terms were changed at the level of the federal government, they were unrelated to the specific labor market or financing conditions in a given firm's county or industry. This feature of the setting not only provides useful cross-sectional variation in the intensity of treatment across county-industries, enabling study of the causal impact of the reform, but also allows for contrasting the effect of treatment on different local labor markets. For example, the researchers can examine how it varied across counties where unemployment rates were particularly high at the time the reform was implemented, or where bank credit was particularly scarce. They therefore can go beyond most studies looking at the labor market effects of financing frictions, as most such studies exploit regional variation in financing frictions to identify causal effects and hence are unable to examine heterogeneity in response across counties or industries.

A second unique element of this study is that since the reform only impacted an identifiable subset of small business contractors to the government, the researchers are able to separate the direct effects of the reform from potential spillovers on firms that did not directly benefit from the reform, allowing study of how the general equilibrium results of the reform may have differed from partial equilibrium effects on firms that were direct beneficiaries of the accelerated cash flows.

They find a substantial impact of accelerated payment on small firms, despite the acceleration being only 15 days. By permanently reducing the assets needed to sustain a dollar of sales to the government, the policy freed up substantial cash flow that could be directed towards firm growth. Each additional accelerated dollar of sales led to almost 10 cents estimated additional increase in payroll over three years, with two-thirds of the increase coming from new hires and the other third from increased earnings per worker, the researchers estimate. To put this magnitude in perspective, a firm that sold 100 percent of its output to the government would have increased payroll 30 percent and employment 20 percent over a three-year period, relative to a firm that did not sell to the government at all. Aggregating these relative effects across firms that were treated, their estimates suggest that the direct effect of the policy was to increase annual payroll by an additional $6 billion, and to create just over 75,000 additional jobs over the three years following the reform. They show that there were no prior trends, and that the effects were not driven by county-sector exposure to government contracts or to small businesses, but by exposure to accelerated contracts only. Consistent with the acceleration of the cash conversion cycle driving payroll growth, they find the effect to be strongest in sectors where receivables account for a larger share of assets and in counties where financing frictions are more severe for small firms.

They also document substantial crowding out of employment growth among non-treated firms. Since the increased demand for labor from treated firms in tighter labor markets also exerts pressure on wages, this makes it relatively harder for non-treated firms to hire, leading them to grow employment slower. They find negative spillovers to be stronger within than across sectors, and provide direct evidence of actual job flows from low to high treatment sectors. Finally, they document that negative spillovers are concentrated in areas with comparatively lower unemployment rates at the time of the reform. The reform had little or no effect elsewhere. This illustrates that the general equilibrium effect of financing constraints on employment might be substantially lower than partial equilibrium estimates suggest, due to competition for inputs in common factor markets.

Overall these findings highlight an important channel through which financial frictions affect firm-level employment, and show how, in the role of a customer, government can directly impact small businesses' financing constraints through accelerated payment of invoices.

 
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