Heterogeneous Effects of Credit Constraints on SMEs’ Employment: Evidence from the European sovereign debt crisis

A growing literature has been examining how firms react to credit constraints by adjusting forthis financial burden through a reduction in labor costs. Evidence on the topic showsheterogeneous employment effects depend on a firm’s characteristics and the market wherethe firm is active. This paper aims to extend the existing limited evidence by investigatingwhether employment decisions of Belgian SMEs were affected by different types of creditconstraints during the European sovereign debt crisis. We exploit detailed Belgian matchedbank-firm data and use the variability in banks’ financial health following the 2008 crisis as anexogenous determinant of firms’ access to credit. The results corroborate the hypothesis thatcredit-constrained SMEs reduced their labor force in the aftermath of the 2008 crisis. Whereasemployment effects were quite similar across different types of loan applications, the effectssignificantly diverged with regards to market demand and competition. SMEs facing negativedemand shocks and fierce competition exhibited a higher tendency to reduce their labor force.In addition, this paper identifies the main strategy taken by SMEs to reduce labor costs.Although most firms adjusted via the extensive margin, the results indicate that SMEs weremore likely to adjust via the intensive margin due to the temporary layoff scheme introduced bythe Belgian government. This finding supports the hypothesis that short-term compensationprogrammes contribute to employee retention during recessions.