Zombification of our businesses
Economic recovery
Banks should be recapitalized and forced to publicly report bad debts, to avoid vszombie companies unable to cover their debt service costs with the profits they generate.
NOTICE: Over the past decade, many countries have experienced consistently low inflation and short-term interest rates, while long-term interest rates have trended downward.
This model is unique in economic history. It asks questions about the effectiveness of monetary policy in running the economy in this environment and whether the way monetary policy affects the economy remains the same. This can create challenges if the environment of low inflation and low interest rates reduces the ability to forecast the economy.
Besides the impact on monetary policy making, low interest rates have also contributed to a phenomenon called “zombification” by reducing the burden of financial pressure on businesses. Zombie businesses are businesses that cannot meet the cost of servicing debt from the profits they generate.
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This phenomenon has been observed all over the world, in Japan and in various European countries. Overall, the number of zombie companies in the developed world has increased since the 1980s. During the Covid-19 crisis, airlines can be seen as zombie companies.
A famous example comes from the Italian cement industry after the global financial crisis. A managing director said in 2017 that in the cement industry, “we have zombies being kept alive by the banks … Banks are doing everything they can to keep these zombies alive in order to avoid realizing losses on their balance sheets “.
A key factor in the creation of zombie companies is the undercapitalization of banks, which prefer to lend to insolvent borrowers in order to hide their losses and increase their chances of receiving government support. At the same time, these banks would increase the cost of borrowing for healthy businesses, an effect economists call the “zombie lending phenomenon”.
By keeping inefficient businesses alive, the Schumpeterian idea of creative destruction or, in other words, the idea of cleaning up the effects of recessions is interrupted.
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Another key factor in building zombie businesses is the accommodating government policy. Research has shown that expansionary policies, such as ultra-low interest rates and quantitative easing, reduce the costs of financing debt and therefore keep inefficient companies alive that would otherwise have left the market.
Because these companies do not leave the market, they create market congestion and lead to excess capacity, i.e. oversupply in the economy. And finally, lower inflation.
Above all, zombie firms reduce productivity in the economy and crowd out investment and employment in more productive firms.
Industries with more zombie firms have been shown to have lower productivity, higher sales growth, lower margins, lower inflation growth, and higher costs compared to industries with higher costs. lower shares of zombie firms.
In addition, in times of recession, zombie firms slow down the reallocation of resources to more productive firms, which slows down the next recovery.
By keeping inefficient businesses alive, the Schumpeterian idea of creative destruction or, in other words, the idea of cleaning up the effects of recessions is interrupted.
These ideas mean that the innovation process is fueled by the destruction of obsolete companies and, therefore, increases the productivity of the economy. In a way, the recession identifies inefficient businesses and shuts them down, freeing up resources used more profitably in efficient businesses.
New Zealand’s economic situation, with low interest rates, low inflation rates and very accommodating government policy – i.e. quantitative easing and wage subsidy programs – could lead to to a zombification of the economy. Companies in sectors such as manufacturing, education and training, transportation, retail or accommodation are candidates for zombification.
What can policymakers do to prevent a zombification of the economy? From a financial stability perspective, banks should be required to publicly report bad debts. This could be done, for example, as part of existing bank stress test procedures.
Additionally, if there is evidence that the financial sector is weak, i.e. if banks are undercapitalized, a targeted recapitalization program, similar to the Troubled Asset Relief Program (TARP) in the United States , is very effective and can shorten recovery. after the Covid recession.
Zombification also supports the use of expansionary fiscal policy over a longer period of time, as it increases aggregate demand that meets the excess capacity created by zombie companies.
Understanding and monitoring the unwanted side effects of accommodative policies is important for monetary and fiscal policy making. Policies must be designed and implemented to ensure that we avoid wasted decades of weak economic growth like in Japan.
