The governments’ response to the pandemic-inspired economic collapse has unleashed yet another economic problem – “Zombie firms”. The Central banks have acted quickly to make money as cheap as possible by making it both plentiful and accessible to support companies through the pandemic downturn. The remedy provided by the Central banks, however, has a sting in its tail. As policymakers make effort to fight the impact of coronavirus upon the economy through job retention schemes and other support measures the concern is that economic recovery will be held back by a troubling rise in the number of debt-laden companies shuffling across a corporate twilight state: a whole generation of zombies. So, what do you think, will this ‘zombification’ of the economy cause the next recession?
To answer this question, you need to first understand what is meant by a “Zombie Firm”.
A zombie firm is a company that earns just enough money to stay in business but is loaded with bad debts and needs bailouts to survive. Such companies struggle to meet overheads (like wages, rent, interest payments on debt) and have no excess capital to invest to spur growth. Zombie companies are often burdened by large amounts of historic debt and have borrowing costs and maybe one just event—market disruption or a poor quarter performance—away from insolvency or a bailout. For example, a company that took on large debts but then due to a rise in interest rates, its debt repayments became unaffordable and it is on the verge of going under – without support from banks or governments.
In terms of an economist, the corporate version of the living dead is a business that’s kept alive by borrowing instead of by making money. Or, for accountants, these are companies that don’t generate enough profit to cover the cost of the interest on their debts.
Zombie companies are also known as the “living dead” as a zombie firm is a going concern but fundamentally broke. However, in rare cases, there is a chance that a Zombie firm could restructure and save its business. Like in the case of General Motors which was offered a subsidy by the U.S. government in the 2009 recession – which helped it to survive its near bankruptcy.
Yet, other economists suggest that it is generally inefficient to prop-up zombie firms as by draining resources such as capital and workers, zombie firms make it more difficult for profitable companies to grow.
What causes firms to become Zombie Firms?
This is no new phenomenon. Even before the Coronavirus pandemic, a decade of ultralow interest rates – close to zero % intended to stimulate the economy after each of three 21st-century recessions created the conditions for zombies to proliferate in developed nations. Put simply, at very low rates, it is affordable to take on debt. However, very low-interest rates can encourage firms to take on debt that might be unsustainable – any firm having a high level of debt is more vulnerable to a rise in interest rates. According to data compiled by Deutsche Bank Securities, nearly one in every five publicly traded U.S. companies is a zombie. The figure has doubled since 2013 and is up dramatically from the late 1990s when almost no half-dead companies were staggering across the landscape.
Some of the other reasons causing the rising number of “living dead” – borrowing in a foreign currency making the firm vulnerable to a devaluation in the currency; fall in demand – if a firm is not able to keep up with changing consumer preferences or technology it can be left with unsold stock and wasted capital investment; deflation – in a period of deflation if a firm has high debt levels, the real value of its debt repayments would increase and the firm may have to cut prices for its goods – due to deflation, but at the same time, its value of debt keeps increasing so it becomes progressively harder to meet the debt repayments; exposure to bad debts elsewhere – for example, many European banks had a strong core business, but they purchased mortgage debt bundles from the US not realizing these debt bundles were actually full of sub-prime debts. When the US housing market fell, there was a rise in mortgage default and these debt bundles lost their value. Consequently, the banks were left with much larger losses than expected.
Apart from the externalities mentioned above, another striking factor contributing to increasing Zombie firms could be – when a bank or finance provider has identified a potential zombie company, but they are unlikely to take action against the historic debt, as long as they receive interest payments. Besides, directors may have provided personal guarantees against these debts, and as a result, they may be dead set against triggering these guarantees by entering voluntary liquidation.
What impact does zombie companies have on a nation’s economy?
Due to the pandemic, the zombies’ share of the market appears to be growing and fueling new risks. Since the pandemic sideswiped the economies, the Central Banks across nations have again lowered borrowing costs to near zero and further eased credit conditions by purchasing corporate bonds. These actions have drawn widespread support as a cure to the COVID-19 induced crisis. Making it easier for companies to borrow should prevent countless business failures and millions of additional job losses. But that short-term success may breed long-term weakness, draining productivity, investment and the economy’s competitive fire once the crisis passes.
Like a recuperating hospital patient relying on painkillers, the economy needs cheap credit to recover. But used for too long, low-interest rates act like a narcotic, leaving the economy craving easy money and unable to thrive without it.
The foremost impact of zombie companies on the economy is that they weaken economic growth. Zombies are a problem for many related reasons. Firstly, they tend to be less productive. A company that can survive by financing instead of finding ways to increase profits can become complacent and inefficient. The low prospects of increasing wages in Zombie companies, after having to deal with historic debts, cause productivity per worker to be much lower. In addition to this, the lack of productivity also keeps tax receipts at a lower level than they could otherwise achieve, resulting in continued austerity.
Secondly, zombies tend to consume scarce resources — personnel, office buildings and capital — and thus leave less for healthy companies, hampering their growth. Not only this but some employees with serious talent may simply be propping up zombie companies. With real opportunities, they may likely be able to produce something more innovative.
The most famous zombie outbreak occurred in Japan, where unprofitable companies famously became prevalent after a financial crisis in 1990. In fact, the term zombie company was originally coined by the media during that time; the banks deemed some companies, with large historic debts, too big to allow to fail. However, allowing such companies to amble along resulted in a market crash in 1990. As confirmed by researchers, industries that experienced more zombification had lower productivity growth, and at the same time, financial capital was diverted away from healthy businesses. This is becoming a rising concern for the U.S., which has already seen creeping zombification, that it might fall victim to a plague of the corporate living dead in the aftermath of the coronavirus.
In a healthy economy, bad companies die and good companies replace them and new industries rise while old ones fade. But if the Central banks in developed nations keep all of the bad companies on life support, neither of those necessary processes can happen. However, at this time when the economy has been badly hit by the pandemic, the governments shouldn’t let up on its lending programs until Covid-19 is eliminated by treatments or vaccines. But it would be useful to have a concrete plan for how to clear out the corporate deadwood once the coronavirus is no longer a threat as supporting unprofitable companies for too long can have detrimental effects on the economy.