During a period of lockdown and recession, fewer companies failed. This was a result of a combination of furlough schemes to reduce wage bills, state-backed loans to provide liquidity and laws to avoid bankruptcies. This in return saved a lot of companies.
But some say surviving in cheap debt and government aid is not a healthy option. The result could end up being a whole new group of what economists call zombie companies.
And just like in the zombie movies, they are dead, but feed off the living.
Should we be worried? And to what extent?
By definition, a Zombie company earns just enough money to continue operating while being unable to pay off its debt. Basically, a firm that can’t generate enough business to operate without financial assistance. They are companies that usually exist on cheap money and government aid.
And although they always existed, the Corona pandemic is creating a greater risk of extra zombification.
If we look at the numbers, there are clear signs that cheap money combined with government actions aimed at saving economies are creating a very fertile scenario that can lead to the rise of zombies.
In 2020, bankruptcies fell 40% in France and Great Britain. Looking at the European Union as a whole, bankruptcies were down 25% on average.
According to a European commission note, without help and new loans, almost a quarter of European Union companies would have liquidity problems by the end of 2020.
The National Bureau of Economic Research, an American Organization, found out that without state-backed loans and subsidized payrolls, European business failures would have almost double in 2020 instead.
At the same time, Central Banks have eased monetary policies all around the world, injecting a lot of cheap money into the economies. The central banks of the world’s 10 biggest economies expanded their balance sheet with nearly $7.5 trillion dollars buying public and private debt.
Outside of the big league, the central banks of 20 emerging market countries deployed asset purchases for the first time. In total, the fiscal policy response to the pandemic can be estimated at around $12 trillion dollars.
In the European Union, almost 2.3 trillion euros in national liquidity support measures helped stave off a rise in insolvencies. A big part of this money was used to provide companies with cheap loans, or in other words, more debt. The corporate debt around the world escalated dramatically during 2020.
In first-world countries alone, corporate debt went from 91% of GDP in 2019 to 102% at the end of September 2020. And keep in mind that the 91% from 2019 was already a record.
So, it’s safe to say companies are in debt like never before. In the European Union, borrowing surged with France, Italy and Spain topping the list.
But you are probably thinking that saving companies from bankruptcy during a pandemic makes sense, right? Well, you are not wrong. But these measures come at a risk.
An economy without growth combined with easy credit is the perfect scenario for a company’s zombification. After all the support is used up, there is a chance companies will survive as zombies – able only to keep repaying their debt, unable to move into profitability.
In the long run, this can lead to long-term stagnation, lower productivity, unemployment and many bad after effects.
Researches point out that zombified companies invest and innovate less, impacting the entire economy. And there is the contagion. In countries with too many zombies firms, healthy companies also invest less.
According to a report by the Bank for International Settlements, a one percent rise in the number of zombie companies translates into a one percentage point decline in capital spending by non-zombies companies.
To better understand the effects, we have to look into some examples from the past. Zombie companies are not a result of the Covid pandemic. They are very well-known economic phenomena that have impacted many countries.
The term was first coined in 1987 to describe U.S. banks kept alive by government bailouts. But the term gained popularity in the 90’s, especially in Japan.
During this time, companies that weren’t profitable were the main reason for the so-called Japanese lost decade. From 1990 to 2000, Japan had low economic growth while banks, unwilling to recognize losses, kept credit flowing to insolvent borrowers.
In the early 2000’s, around 30% of Japanese public companies in construction, real estate, manufacturing, retail and services were unprofitable, kept alive solely by bank loans.
The economy suffered from a dormant labor market and low productivity. GDP grew only 1.14% annually, below other industrialized nations. But although Japan’s lost decade popularized the term, the zombie phenomenon was known beyond its borders.
The Bank of International Settlements estimated that the share of zombie companies in Western countries increased from 1% to 12% between 1990 and 2016.
But what is the solution? Should governments just let the business fail and move on? Well, according to specialists, extreme situations like the Coronavirus pandemic require help in form of cheap loans and furlough schemes, but governments do need to know when to stop, otherwise the good intentions might turn out to be counterproductive. And the European Union seems to be aware of that.
A European Commission note from February 2021 stated that almost half of all firms that would have liquidity problems during 2020 because of the pandemic were already at a high risk of default before the crisis.
According to the paper, due to the pandemic, the companies burnt not only through their own cash reserves and money provided by government funding but also increased the amount of bank loans.
The challenge now is to figure out which companies need help to survive an economy in lockdown, and later can continue generating revenues, profits and jobs once things start getting better. And which companies are simply using this money to prolong their already moribund business.
To do that, one of the solutions propagated by specialists is that countries should stop supporting companies, but focus on the workers.
In summary, generous unemployment benefits would be more helpful than a continuous flow of cheap loans with no end in sight. Interest rates should also be raised eventually, as loans with artificially low-interest rates also contributes to the zombification of these companies.
Some also believe that governments should create ways of allowing companies to fail quickly. Instead of trying to save what in some cases is an inevitable situation, companies should be able to quickly and efficiently declare their insolvency and in some cases be offered alternatives to possibly recapitalize or redirect their assets and employees.
Governments and central banks should be looking into how to do that, instead of trying to save the unsalvageable. The European Union doesn’t seem to be ready to take these steps yet.
In the last two weeks of March 2021, the central banks of the European Union have bought an average of 20 billion euros worth of debt securities per week, mainly to keep financing conditions of governments and companies.
Christine Lagarde, president of the European Central Bank, said that the pandemic bond program is set to run until March 2022 and can be extended if the ECB deems it necessary.
Until then, cheap money will still be available to companies. The European Union challenge is to figure out a way to keep loan options open to viable companies, not to every company.
Saving economies from a deadly pandemic that has the world in its grip is one thing. Providing cheap money and contributing to the zombification is something else.
Knowing the limits seems to be the most important thing. Otherwise, the zombies might rise and just like in a horror film, they will feed off the living, slowing down any chance of recovering.
