Once in a while, I get friends who like to submit requests on topics I can cover. One such topic is that of zombie firms during the pandemic. What is a zombie firm or zombie company? A zombie firm is a company that earns just enough to continue operations and servicing debt, but is incapable of paying off of debt. More specifically, a common definition of a zombie firm is a business coverage ratio of less than 1 for three consecutive years. They are called "zombies" because they are close to insolvency but do not quite make it to that level. The term "zombie firm" was coined during Japan's "Lost Decade," which refers to Japan's economic stagnation in the early 1990s when Japan's asset price bubble burst. The Congressional Research Service provides a nice primer on the topic.
Why are zombie firms so problematic? As the Bank of International Settlements [BIS] brings up in their study on the topic (Banerjee and Hoffman, 2018), zombie firms are a problem because they are less productive and crowd out more profitable firms (also see Caballero et al., 2008). How so? Under normal circumstances, these firms would exit the market and make way for newer and more productive firms. However, zombie firms stay afloat because they have access to an abundance of credit, much like we have seen when the U.S. Federal Reserve decided to lower interest rates to near-zero or created emergency lending programs in response to the pandemic. For more information on zombie firms and weak productivity, you can read OECD resources here.
On the one hand, I feel better about zombie firms now than I would have a year ago because the economy is recovering. Zombie firms tend to die a natural death once the economic situation improves. This is why I am happy to see unemployment benefits be curtailed by states: lavish unemployment benefits slow down economic recoveries. The sooner we can recover, the sooner we can lower the rate of zombie firms.
On the other hand, I worry about how monetary policy plays a role in keeping these firms afloat. While there is a potential case for such lending from the Federal Reserve in the short-run in terms of boosting aggregate demand and increasing employment and investment, what happens in the long-run is that the credit is based on firm size or sector, thereby creating a misallocation. This is another reason why low or negative interest rates are problematic beyond the short-term: because such rates lock economies into a vicious cycle of anemic economic growth, much like we have seen in the European Union and Japan.
The Peterson Institute for International Economics is correct in saying that we need to push the economy above potential. As long as we create an economy with tax, regulatory, and trade dynamism, we can help reduce the rate of zombie firms.
Is "misallocation" what Austrian economists call "malinvestment"? I.e. when credit expansion pushes interest rates down below their natural rate (the rate determined by society's time preference or preference for saving over consumption), all of a sudden investment in certain long-term projects becomes profitable even though consumers are not actually making the necessary saving to afford those products when they are ready to go to market. Sorry I'm an economics auto-didact who has mainly read Austrian stuff and am not very familiar with the mainstream terminology.
ReplyDeleteReally glad to find this blog, though. I'm interested in converting to Judaism but am put off by the progressive ideology of so many Jews, including the rabbi overseeing my conversion. I just want to make sure believing in compulsory wealth redistribution is not an article of faith!