Has furlough prevented household financial distress during the pandemic?

The Coronavirus Job Retention Scheme may have helped to prevent a big rise in the number of UK households in financial distress. But its effects have not been equal, and those on lower incomes have been more likely to cut their spending, draw on savings and face financial hardship.

The UK government’s Coronavirus Job Retention Scheme (CJRS) was set up to safeguard jobs and incomes during the Covid-19 crisis by allowing employers to place workers on temporary leave rather than making them redundant. Was the scheme designed effectively and has it prevented widespread financial distress among UK households?

During a spell on furlough, the government has paid part of a worker’s wages up to a maximum amount. While employers have had discretion to pay the remaining salary, many have chosen not to. Furloughed individuals have had to compensate for the income shortfall by adjusting their spending patterns or drawing down savings. Unless these adjustments are sufficient to cover the entire income shortfall, being furloughed has imposed a risk of financial distress on households. Evidence suggests that the CJRS has had only a modest effect on increasing the incidence of financial distress.

While the CJRS was introduced with the aim of protecting jobs and incomes, it also needs to remain financially sustainable. The overall cost of the CJRS imposes a substantial burden on the public finances: the government spent almost £70 billion on the scheme to cover the wages of 11.6 million people.

Recent research shows that the design of the scheme has been successful in the sense that it has mitigated a big rise in the number of households experiencing financial hardship at the lowest cost to taxpayers.

Taking stock

The UK government introduced the furlough scheme in March 2020 and it comes to an end this month (September 2021). During this time, almost a quarter of the workforce has been furloughed at least once.

Figure 1 shows that firms principally furloughed staff at the beginning of national lockdowns, as these were times of acute uncertainty about future business conditions. In particular during these periods, it was unclear how long disruptions to supply chains would be, and how sales and workplace restrictions would affect firms’ profit streams adversely.

Where firms have limited cash reserves or available credit, reducing the wage bill is an effective way to reduce costs and relax financial constraints. While furloughing workers allows businesses to reduce operating costs, the policy also benefits workers by enabling them to retain their relationships with their employers, something that would not happen in the case of redundancy. This means that workers can return to work easily after furlough ends, and it allows firms to expand their activities quickly once business conditions improve by drawing from furloughed staff.

It is likely that the CJRS has prevented a substantial rise in the level of unemployment. The scheme had been an important stabilisation policy during the pandemic by preventing large shortfalls in employees’ incomes that would have occurred if they were it had been made redundant. Nevertheless, being furloughed implies a substantial reduction in a worker’s income.

Figure 1: Number of furloughed employees

Source: HMRC coronavirus (Covid-19) statistics
Note: The grey shaded bars show the times of national lockdowns

Has the furlough-induced income decline resulted in a surge of households in financial distress?

To understand the effect of furlough on household finances, it is important to track individuals before, during and after a furlough spell. The Understanding Society database is one of the most established household surveys in the UK. It tracks a large set of households over time and is representative of the UK population.

Over the course of the pandemic, Understanding Society collected eight waves of data through a special Covid-19 survey, which provides a window into households’ changing circumstances.

Under the CJRS, the government pays 80% of furloughed workers’ wages up to £2,500 per month. Evidence using the Understanding Society survey shows that the average individual experienced a furlough-induced income reduction of 17%.

For households with low income or savings, this was a particularly large shock as they did not have sufficient savings to offset the reduction in their income while remaining able to meet unavoidable current expenditure. Whether a household experiences severe financial difficulties can be measured by their ability to pay bills for housing and other consumption goods.

During the pandemic, a furloughed individual has been 30% more likely to be late on housing payments and 9% more likely to be late on bill payments, relative to a non-furloughed individual. Despite these large relative effects, the shortfall in income from being furloughed has had a modest impact on the level of financial distress in the UK workforce: furlough-implied income reductions increase the overall incidence of financial distress by only 2.3 percentage points.

In this sense, the design of the CJRS has been successful in mitigating a big rise in the number of households experiencing financial hardship.

What are the implications of household actions taken to avoid financial distress?

Furloughed workers have drawn down savings to stabilise their finances in the face of a furlough-induced income reduction. While on furlough, individuals have been 7 percentage points more likely to cut savings in comparison with pre-pandemic levels. Households have also attempted to relax the furlough-imposed tighter financial constraints by cutting spending. A furloughed individual has been 20 percentage points more likely to cut spending, relative to pre-pandemic levels, than a person who has not been furloughed.

Importantly, the cut in household spending persists even after returning to work. Since about a quarter of households have been furloughed at least once, being placed on the CJRS has a long-lasting effect on consumption behaviour for a large part of the UK population. Owing to furloughed workers’ spending adjustments after returning to work, they are significantly less likely to experience financial distress compared with non-furloughed individuals.

Evidence also shows that furlough provokes inequality. Furlough disproportionately increases the probability of ending up in financial distress for those households in the lower half of the income distribution and among those without a university degree. The furlough-implied reductions in consumption and savings are also particularly strong for this group of households.

Despite the positive effects of the CJRS in preventing mass unemployment and widespread financial hardship, it has asymmetric effects, as the adverse implications of the policy are concentrated among individuals with lower incomes and lower educational attainment.

Could the design of the CJRS be improved?

The CJRS has imposed a substantial burden on the UK’s public finances. By mid-August 2021, the UK government had spent £69 billion on the scheme, which equates to 8% of annual government spending. At the same time, in the 2020/21 tax year, government borrowing has been the highest since records began in 1946.

The evidence above suggests that the income shortfall for those on the furlough scheme only very moderately raised the overall occurrence of household financial distress. Unquestionably, the individuals who slipped into financial hardship from being furloughed experienced a very difficult time.

Nonetheless, the question arises whether a government contribution below 80% of monthly wages would have been sufficient to limit the overall increase in financial hardship, since it would come at the benefit of reducing the burden on taxpayers. Germany and France, for example, successfully used furlough schemes with only around 60% income compensation payments to mitigate the adverse effects of the global financial crisis of 2007-09.

Estimates using the Understanding Society Covid-19 survey provide insights into how changing the government’s furlough payments might have influenced financial distress. Figure 2 shows that furlough-induced income contractions of 20% or less have little bearing on the incidence of financial distress. As a result, increasing the government’s contribution would do little to lower the incidence of financial distress among furloughed workers.

In contrast, above income contractions of 20%, the probability of financial distress increases exponentially. At a 40% income reduction, the probability of financial distress is 31% higher relative to the incidence among non-furloughed individuals. This suggests that the government’s contribution of 80% to monthly wages minimised the incidence of financial distress at the lowest cost to taxpayers.

Figure 2: Effects of decline in income due to furlough on probability of financial distress

Source: Understanding Society

This is an important insight on the effectiveness of the design of the CJRS. It is particularly relevant as the pandemic continues and a re-introduction of the CJRS may be required in future.

Furlough schemes have been introduced in many countries to dampen the adverse effects of the Covid-19 crisis. The specific designs of the schemes vary substantially, which may partly be due to a wide range of additional social security mechanisms. Nonetheless, the evidence discussed above provide an insight into the effects of furlough schemes on household finances elsewhere.

It is clear that furlough schemes around the world have been an important cornerstone of governments’ efforts to mitigate the damage of the Covid-19 crisis on firm and household finances.

Where can I find out more?

Understanding Society: Covid-19 study.
The effects of the coronavirus crisis on workers. Flash findings from the Resolution Foundation’s coronavirus survey.
Office for National Statistics. Economic activity and social change in the UK, real-time indicators: 23 September 2021.
Decision Maker Panel: Survey of UK firms’ business expectations run by the Bank of England, Stanford University and the University of Nottingham.