This post first appeared in In The Black, 5 Dec, 2017 https://www.intheblack.com/articles/2017/12/05/zombie-firms
Zombie firms – dud businesses that refuse to die despite not being commercially viable – are not only surviving but multiplying, and acting as deadweight on productivity and growth.
In the hit American schlock-horror show The Walking Dead, the sweaty heroes make killing off zombies look sickening but easy, casually shooting, bludgeoning and slashing their way through swarms of mindless goons to get out of trouble.
Alas, that is not how it is proving to be in the real world.
Across the globe, zombie firms live on, creating a headache for competitors and governments.
Here come the zombies
In well-functioning competitive markets, firms are under constant pressure to perform or lose market share and eventually go out of business.
Contradicting that notion, researchers at the Organisation for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF) have identified a disturbing trend for chronically under-performing companies to survive.
The OECD study found that between 2003 and 2013 the proportion of all European firms that were zombies (defined as older enterprises chronically unable to meet interest payments) almost doubled from 3 to 5 per cent.
Much of this increase has occurred since the global financial crisis (GFC), and the OECD researchers think they know why.
Usually recessions have a cleansing effect, brutally killing off enterprises which are no longer viable so that only the robust survive.
OECD researchers, however, say that the nature of the GFC and the policy responses to it has blunted this process. Thanks to persistent ultra-low interest rates, carrying high levels of debt is no longer the death sentence it once was. In addition, banks are showing greater forbearance in dealing with debtors, and governments have increased business support to protect jobs.
Zombie firms globally
Zombie firms are not just a European problem. The IMF warns that the Chinese economy is also being weighed down by zombie firms.
In its most recent assessment, the IMF found that China could increase productivity by making better use of resources that are going to zombie firms as well as to industries with overcapacity and state-owned enterprises (SOEs).
It is urging the Chinese government to intensify its efforts to reform the economy, including allowing underperforming firms to fail, reform SOEs and reduce over-capacity.
Low productivity growth
Economists have puzzled over why productivity growth in recent years has been so lacklustre, and particularly why the practices of the most productive firms are not disseminating through industry in the way that they used to.
The OECD researchers believe that zombie firms are a large part of the problem.
By surviving despite using outdated equipment, processes and practices, zombie firms not only drag down aggregate productivity, they also make it harder for new entrants into the market and hinder the efficient allocation of jobs and investment.
Businesses trying to crack markets congested by zombie firms are forced to clear a much higher productivity threshold to compensate for the lower profits they are able to earn because of the inflated wages and lower prices driven by their zombie rivals.
The researchers estimate that investment in productive enterprises would have been 2 per cent higher in Europe in 2013 had there not been an increase in the number of zombie firms.
An IMF working paper on China estimates that getting rid of zombie firms could generate significant gains of 0.7-1.2 percentage points in long-term growth per year.
It says the Chinese government has made zombie firms a key priority in its strategy to address corporate debt vulnerabilities and improve resource allocation, but finds zombie numbers have increased since 2011.
“Implicit guarantees and the government’s desire to support growth encourage these firms to invest excessively, raising already-high leverage while weakening performance on profitability and debt service capacity,” says the paper.
Zombie firms and Australia’s car industry
When the final car rolled off the Holden assembly line in Adelaide in October 2017, it marked the end of a decades-long effort by successive Australian governments to foster a viable local automobile industry, initially using high tariff walls and later by providing billions of dollars of taxpayer assistance.
“If we gave as much attention to them as to the car assemblers, our car industry would be in a much healthier situation,” he says.
Killing off zombie firms in the real world is much more difficult than annihilating fictional ones in the movies, but the experience in Australia, China and Europe shows that allowing them to continue can perpetuate the pain to economies.