How Zombie Firms Are Contributing to the Global Productivity Slowdown
Updated: Mar 11, 2020
by Shubhangi Kumar
“Historical research has shown that real output per person in Britain between 1300 and 1700 barely doubled in four centuries, in contrast to the experience of Americans in the twentieth century who enjoyed a doubling every 32 years.”
Perhaps no other point illustrates so assertively the importance of productivity growth as Robert Gordon’s observation in his book, The Rise and Fall of American Growth. When electricity, machinery, automobiles and the Internet were introduced to workers’ lives, there was nothing to prevent the output per worker – and consequently, GDP – from exploding.
That productivity growth leads to economic growth is one of the most undisputed statements in economics, and this growth engine is becoming even more important as workforces decline and populations age. Yet, as the gains from the IT revolution of the 90s ebb away and the aftereffects of the financial crisis still remain, productivity growth is declining in most developed countries, with historic lows being reached in Western Europe. Across Spain, Sweden, Germany, Italy, the UK, the USA and France, average labour productivity growth dropped to 0.5% in 2010-14, from 2.4% just a decade earlier.
Average productivity of the seven countries from 1871 to 2016; Source: McKinsey Global Institute
A recent working paper by the OECD reveals that zombie firms also have a significant role to play in this slowdown. Defined as firms aged ten years or more with an interest-coverage ratio, i.e., the ratio of earnings before interest and taxes (EBIT) to interest expenditures, of less than one for three consecutive years, these are firms which essentially are depending on creditors for their survival. The term came into usage after being used to describe Japanese companies that were supported by Japanese banks during the Lost Decade after the collapse of the Japanese asset bubble but would have otherwise had to declare bankruptcy – firms that were obviously dead but stayed alive after receiving support: zombies. Daiei, the Japanese retailer, is an example. The likelihood of being a zombie firm increases with size and age. Bigger, older firms normally employ a large number of people, thus incentivising governments to support them.
Most importantly, they have a significantly lower productivity growth than other firms, leading to serious consequences and market distortions. Not only do they pull down the average productivity, they also lead to zombie congestion: the crowding out of investment in more efficient firms and the prevention of more efficient firms from gaining market share. This stifling of expansion, combined with the rise in wages due to inefficiency in the allocation of resources, eats into the profits of the non-zombie firms. New firms face increased barriers to entry in terms of fewer available resources and an increased threshold productivity required to enter the market, consequently increasing the difference in productivity between zombie and non-zombie firms. Zombie-dominated industries have low job turnover, low investment and low employment.
Unfortunately, both the prevalence of zombie firms and the resources sunk in them has risen since the mid-2000s, with a roughly 3.5% increase in the share of zombie firms in 9 OECD countries that should correspond to a 1.2% decline in labour productivity. This is a surprising result given the Great Recession of 2008, as recessions tend to brutally eliminate inefficient firms.
Share of zombie firms over time; Source: OECD
Counterfactual analysis estimates that the reduction of zombie firms to country minimum levels could increase investment in non-zombie firms from 0.4% to 4.7%, depending on the country. What is the way forward then? The prevalence of zombie firms has been associated with weak banks and poorly designed insolvency policies. The OECD has commended the UK’s insolvency framework as the best, as it is structured to take less time, be easily dealt with outside court and be triggered by creditors. The minimum bankruptcy term for an entrepreneur is one year, as compared to five in Estonia.
As Paul Krugman said, productivity is nearly everything in the long run. Zombie firms have been dragging down growth globally, especially in Japan, and it is time we put them to rest with an arrow through the head.
Bibliography
[1] Robert Gordon, The Rise and Fall of American Growth
[3] Adalet McGowan, M., D. Andrews and V. Millot (2017), “The Walking Dead?: Zombie Firms and Productivity Performance in OECD Countries”, OECD Economics Department Working Papers, No. 1372, OECD Publishing, Paris, https://doi.org/10.1787/180d80ad-en.
[4] https://www.economist.com/buttonwoods-notebook/2017/01/12/attack-of-the-zombie-firms