To manage the consequences of unexpected shocks, policymakers need to understand how firms respond to such shocks. This column uses linked, high-frequency survey micro data to analyse the high-dimensional responses of UK firms to the recent energy price shock. It finds that firms adjust along multiple margins, such as passing on costs to prices, building up cash reserves, increasing debt levels, and shifting towards remote working arrangements. As governments consider how to support firms during the ongoing energy crisis, the findings indicate that interventions should target firm size and industry needs.
Countries around the world are having to grapple with the economic repercussions of geopolitical tensions and other unexpected shocks. The latest in a long list of recent shocks is Russia’s ongoing invasion of Ukraine, which caused a spike in energy prices and disrupted global supply chains. To manage the economic fallout from these shocks successfully, policymakers need to understand how firms respond to them.
The impact of the energy shock
Russia’s war in Ukraine has had profound effects on energy prices worldwide, most notably in Europe. In the UK, wholesale energy prices quadrupled within a few months (see Figure 1). For many firms, this shock prompted immediate concerns about survival, given the fundamental role of energy in many production processes. There are strong reasons to believe that firm responses to such a shock are not homogeneous: supply-side factors such as size (Kalemli-Ozcan and Saffie 2023), production technology (Durante et al. 2022), market structure (Duso and Szucs 2017), and firm management (Lamorgese et al. 2022, Jones et al. 2024) can each affect the precise bundle of actions an affected firm might take. So can demand-side factors (Fabra and Reguant 2014). The recent energy price shock in particular bore the hallmarks of a reallocation shock, with firms adjusting their inputs, outputs, prices, and production processes in many ways.
We leverage a novel combination of linked, high-frequency survey microdata, a pre-registered analysis plan and analytical tools to analyse high-dimensional responses to document how firms with differential exposure to energy prices within and between industries react along a broad range of margins such as adjusting output prices, managing inputs, maintaining processes, and ultimately striving to survive in a transformed economic landscape. 1
Figure 1 UK wholesale gas prices
Methodological advances
We highlight the usefulness of existing but under-utilised real-time survey and administrative microdata collected by the UK Office for National Statistics to help policymakers understand economic shocks in real time. In addition, we identify areas where existing data sources are lacking, either because survey and administrative data give conflicting results, or because researchers are forced to use coarse subjective data instead of high-quality administrative data that are already collected but not yet made accessible for research purposes. This effectively constrains policy effectiveness or under-utilises informational resources that could render fiscal interventions more effective (Fetzer et al. 2024, Feld and Fetzer 2024).
We also develop a data framework to analyse firm responses to economic shocks in near-real time, which we then apply to understanding firm responses to the energy price shock. Our methodology combines a transparent research design that lays open what variation is used to identify the effects, with advanced, high-dimensional analysis techniques to provide a nuanced understanding of how these responses differ by size and industry. To discipline the analysis, we laid out these methods in a publicly accessible pre-analysis plan before any initial data exploration.
Main findings
- Cost pass-through: On average, firms tend to pass through some of the increased energy costs to their customers. However, this pass-through varies significantly by size. Smaller firms are generally more likely to increase their output prices compared to larger firms, who tend to absorb some of the costs and invest more in capital improvements instead.
- Financial adjustments: Firms do not yet lay off workers or declare bankruptcies in noticeable numbers. Instead, they build up cash reserves and increase their debt levels as a response to the shock. This trend is particularly pronounced among small firms.
- Operational changes: Our research indicates that businesses are altering their operational practices in response to energy prices. Most notably, both large and small firms are shifting towards more remote working arrangements, which can shift some energy costs to employees, illustrating an adaptive strategy to manage rising overheads.
- Industry differences: The reactions of firms are highly heterogeneous and vary depending on size and industry. For instance, while construction firms are investing in capital, smaller businesses in the hospitality sector are increasing their stock levels instead.
- Survival rates: Interestingly, our research suggests that despite the economic pressures, firms do not perceive an imminent threat to their survival in the immediate term. Confidence among small business owners remains high, even as the administrative data show signs of increased business exits among small firms.
Implications for policymakers
This research not only provides insights into how businesses adapt to the current energy crisis, but also offers lessons for future policy design. In the short term, as governments consider how to support firms during the ongoing energy crisis, our findings indicate that interventions should target firm size and industry needs (Cox et al. 2024).
For instance, our findings indicate the importance of tailored business support that recognises the differing impacts of energy price shocks across sectors. Moreover, policies to support struggling businesses may differ from those aimed at facilitating rapid adaptation to changing market conditions. The ability to accurately measure and analyse firm responses in near-real time is paramount for getting this targeting right.
In the long run, firm adaptations to the energy price shock can teach us about the path to a greener, more prosperous economy. Understanding these responses provides invaluable evidence for developing targeted policies that promote resilience in the long term. Our study serves as a vital resource for policymakers, helping to chart an evidence-based course through the complexities of the energy crisis, all while keeping an eye towards the larger goal of achieving a sustainable future.
Conclusion
In a world of uncertainty, having the tools to adapt can make all the difference – for businesses and for policymakers. The observations drawn from our work on the energy crisis may well serve as a blueprint for navigating future economic challenges, ensuring that firms are not just surviving, but thriving in a changing world.
Source : VOXeu
