Fed Study Suggests Zombie Companies Not as Scary as Thought

Chris Gaetano
Published Date:
Dec 14, 2020
Zombie companies, that is, businesses that cannot survive without constant injections of new credit, have proliferated during the pandemic, but one recent study by the Federal Reserve suggests they might not be as bad for the economy as some believe, reported the Financial Times.

Zombie companies had been steadily growing even before the pandemic; in 2019, a study by the Bank of International Settlements estimated that 12 percent of all companies in the world are financially undead. In June, a Deutsche Bank analysis placed the figure closer to 18 percent. By November, estimates began reaching 20 percent of the largest public firms. The rise of the zombie horde is largely an artifact of the Federal Reserve's emergency policies instituted earlier this year. A combination of near-zero interest rates and a pledge to buy corporate debt in any amount needed to shore up the economy has made credit dirt cheap, which has enabled these companies to keep borrowing with little cost or consequence. The Fed took these actions to prevent the credit market from freezing up, but, given the rise of undead companies as a result, it may have been a Faustian bargain.

The problem with zombie companies is that they take up resources that might have gone to more efficient firms, thus depressing overall economic competitiveness. One 2018 study found, after controlling for cyclical effects, that within industries over the period 2003–2013, a higher share of industry capital sunk in zombie firms is associated with lower investment and employment growth of the typical non-zombie firm and less productivity-enhancing capital reallocation. Another study from that same year found that the easy access to credit that creates zombie firms can allow "less efficient incumbent firms to remain longer on the market, thereby discouraging entry of new and potentially more efficient innovators." Even though easy credit also helps entrepreneurs innovate, the researchers found that it can inflict, and has inflicted, long-term economic damage, saying that the "decline in productivity growth in most advanced countries since the 1970s may indeed be partly related to an overall easier access to credit due to financial liberalization over the period" and that "[t]his mechanism may have been amplified by the decrease of interest rates and the capital abundance observed in the last decade."

Yet, the recent Fed study, using a database across 17 economies going back to the 19th century, found no evidence that corporate debt booms result in deeper declines in investment or output, or that the economy takes longer to recover than at other times.  Further, it found that there is no evidence that big corporate debt overhangs made economies more fragile, and prone to less frequent but bigger downturns.

The reason for this outcome is that the bankruptcy process generally is smooth and efficient for corporations, compared to individuals. Creditors are usually made whole during this process. The paper concluded, then, that policymakers should focus more on further improving the bankruptcy process rather than on the zombie companies that will eventually need to take advantage of it.

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