We are in a crisis the likes of which will almost certainly end the lives of stolid businesses, so obviously it’s a great time to talk about the benefits of that. In the short run, job losses are, of course, terrible. In the long run, creative destruction plays an important role in the evolution of the economy and society as a whole. When unproductive firms continue to shamble along, the capital available to innovators is wasted on life support for laggards.
Economic data point to a close relationship between declining productivity and a rising portion of capital being allocated to what are colloquially referred to as ‘zombie’ firms. It’s consistent across time and countries. It’s estimated that employment is 1% lower per standard deviation of the zombie share of capital and that the productivity of zombie firms is more than 10% lower than the average non-zombie firm. The problem was exacerbated by near-zero interest rates, which made it easier for banks to continue rolling over questionable debt, and more stringent capital requirements, disincentivizing poorly capitalized banks from taking losses on bad debt. In other words, banks will often refinance bad loans to low-productivity firms using cheap money rather than take losses on the loans and face the accompanying decline on paper assets. This cocktail of cheap capital for inefficient incumbent firms helped zombie firms nearly double in capital share from 2009 to 2013.
The endgame: zombies are eating our brains! That is to say, low productivity firms are crowding out younger and more innovative firms, thereby stifling productivity growth and expanded employment rates. The difficulties, both in firm productivity and jobs, have expanded as the share of the economy taken up by zombies has increased. Think of it as a garden; if we do not prune the unhealthy bits, growth will be stunted for young, healthy plants. Sickly firms are sucking up too much of the available nutrients and preventing sunlight from reaching newly emerged sprouts.
The problem, of course, is that we are talking about people’s livelihoods. In theory, the end of old firms can help propel new ones forward. Practically, many will be out of work as an immediate result. This is why politicians’ first instinct is to throw a lifeline. However, rather than keeping a firm afloat, we should be thinking of the governed. Expanded unemployment benefits could ease the pain while not interfering with the market; providing people with income also helps keep demand steady in communities relying on a single industry or company.
Typically, downturns in business cycles result in the cleansing of weak firms. The last downturn, however, was combatted with unprecedented monetary support. Actions taken by the Federal Reserve likely averted another long spell of 20% or higher unemployment. They also may have set the stage for the anemic productivity growth we have faced over the past decade. In a world awash in capital, low-performing firms are having little difficulty refinancing or rolling over debt. We now face an entirely different kind of crisis; a pandemic is damming the river of economic activity. Zombie firms will once again struggle to find the cheap money they need to survive. As our lawmakers continue to work on fiscal stimulus, I would urge more focus on individuals and less on highly leveraged legacy firms.
Read more of the series here.