Opinion article

The Federal Budget must prepare Australia to be resilient in the face of business failures and restructures

CEDA Chief Economist, Jarrod Ball, says the upcoming Federal Budget needs to provide a better set of tools to manage the wave of insolvencies and restructures coming our way next year.

The Treasurer’s announcement of a major overhaul of small business insolvency last week was an important milestone in defining Australia’s post-COVID-19 business environment.  

Australia needs a better set of tools to manage the wave of insolvencies and restructures coming our way next year. Small business is a logical place to start; before the pandemic hit, small businesses with small liabilities made up the bulk of insolvencies. 

The mountain of support available to businesses through JobKeeper, lending facilities and temporary relief for company directors, has bought many companies and their workers time to hibernate through the COVID winter. Recent extensions to these arrangements are now likely to tide many businesses over until autumn 2021.  

These policies have bought companies so much time that amid the toughest business conditions of the last century, the number of firms entering external administration is well below what would be expected even in a good year.  

But come 2021, there will be no escaping difficult decisions for many firms in Australia and abroad. In July, more than a third of businesses said they would find it difficult or very difficult to meet their financial commitments over the next three months. That number was considerably higher in sectors such as accommodation and food services, where 71 per cent said it would be difficult. 

Handling Australia’s business restructuring task on the other side of this crisis will be a difficult balancing act. The first goal is to smooth the exit from the shutdown and keep viable businesses afloat. The second goal is to ensure timely and efficient insolvencies of nonviable businesses. This should avoid zombie firms incurring debts that can’t be repaid across their supply chains, risking a dangerous contagion that becomes another obstacle to new growth and recovery opportunities. 

As much as we want to preserve viable businesses and the jobs they create, for some, the severity of the COVID winter and a slow recovery will be too much, and workers will be better off the sooner they can find new jobs elsewhere. International air traffic is not expected to recover until 2024, opening a gap in demand that no amount of adaptation or government support can bridge for some firms. 

It will be unproductive to delay the painful restructuring task for too long. There is a reason Joseph Schumpeter coined the term “creative destruction” in the aftermath of the Great Depression – the one silver lining of the massive dislocation it wrought was the space it created for new and innovative firms to grow. If there is a similar silver lining in the COVID-induced recession, this could benefit Australia, given there were concerns before the pandemic about a lack of dynamism in our economy.  

On the other hand, there is clearly an interest in restructuring otherwise viable businesses that have been frozen in the COVID winter. More than any other downturn in recent memory, business fortunes during this recession have often been driven by luck – depending on where the business is located, and what sector it operates in – and the success or otherwise of health policy responses, rather than survival of the fittest.  

This luck has revealed striking cases of feast and famine. Looking at the results by sector, spending on “going out” for a meal is 20 per cent below pre-COVID levels, yet spending on “staying at home” through recreational goods, alcohol, electronic goods and hardware is up 30 per cent. And when it comes to location, closed borders and West Australians’ intrastate travel appetite is driving a Broome travel boom. Meanwhile, Sydney tourism operators, with their almost 60 per cent reliance on international tourism, continue to suffer as international borders remain closed.  

Will the Treasurer’s reforms help navigate this delicate balancing act, recognising that otherwise viable firms have been decimated by the pandemic?  

The planned overhaul means small business should now have more space to wind-up or restructure, with faster processes for distressed but viable businesses to restructure their debts and simplified liquidation for those who won’t make it to the other side. It should also encourage small business owners to start making tough decisions and painful adjustments with greater confidence.  

Comparisons of these insolvency changes to longstanding US Chapter 11 bankruptcy processes have been overdone. These reforms appear to avoid the worst aspects of the US regime, which can lead to a slow, cumbersome and expensive bankruptcy process. 

The challenges will be in the implementation. Will cautious creditors accept businesses piling on more debt as they restructure amid a fragile and uncertain economic environment? Will the insolvency and restructuring profession have the bandwidth to navigate these changes, and if they don’t, will this further exacerbate the recent growth of dodgy insolvency advisers?  

And what about bigger businesses, where the stakes are much higher? Just as small business needs a fit-for-purpose insolvency regime, we need a framework for larger firms that avoids the burden of long liquidations, excessive reporting and appeals processes. 

There is speculation the government will introduce new loss carry-back provisions in Tuesday’s Federal Budget. Under such a plan, a company that has paid tax on profits in previous years would now be able to claim back a refund to offset a loss. Targeting cashflow assistance through the tax system at businesses that were otherwise profitable before COVID-19 is a good example of a measure that gets the delicate balancing act right. Let’s hope that any other new budget measures do the same. 

As hard as 2020 has been, we are about to enter one of the most challenging periods of business adjustment Australia has seen. An orderly process of restructuring and liquidation for Australian business – both big and small – will give our economy more chance to grow on the other side. 

About the authors

Jarrod Ball

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Jarrod Ball joined CEDA as Chief Economist in 2017 with over 15 years of experience as an economist across the public and private sectors. He has held senior roles at the Business Council of Australia, in EY’s advisory services practice and more recently at BHP. Jarrod also worked in the Federal Government and was a lead adviser on microeconomic reform for the Victorian Departments of Premier and Cabinet and Treasury and Finance. He is a member of CEDA’s Council on Economic Policy and the Melbourne Economic Forum. Jarrod holds a Masters degree in Economics from Monash University and undergraduate degrees in Business (Economics) and Arts from the University of Southern Queensland.

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