The economies of developed countries have being stuck in a low growth gear ever since the financial crisis.
Stephen King, HSBC’s senior economic adviser, had a few prescriptions to cure the problem from fiscal stimulus to increasing world trade, but one suggestion was a particularly unique way of dealing with it: Let already-dead — or “zombie” — companies collapse.
King’s thought is this: after the financial crisis, central banks and governments’ efforts to boost economic growth by buying up assets inadvertently reallocated capital to failing companies.
This kept those companies afloat and goosed employment, achieving a short-term goal. In the process, however, it prevented a shift away from these ineffective companies to those companies that could’ve been more productive today.
Here’s King’s full explanation (emphasis ours):
Quantitative easing worked domestically through its effect on the value of real estate and financial assets, most obviously corporate bonds and equities. Higher values for financial assets meant that companies which, in other circumstances, would have been under pressure to reduce their costs could carry on with business as usual.
Put another way, they could happily employ people who might otherwise have lost their jobs. Capital markets were thus no longer able easily to perform their central function, namely the efficient allocation of capital. Too much capital stayed in bloated and inefficient companies leaving too little to support the growth of smaller, more dynamic, enterprises. It was, perhaps, a western version of the Japanese ‘zombie company’ problem.
These “zombie companies” are now holding back the kind of companies that would help drive productivity growth and innovation.
“Zombie companies preserve inefficiencies and dampen enterprise,” wrote King. “Their preservation limits the ‘creative destruction’ that Joseph Schumpeter famously described in his ‘Capitalism, Socialism and Democracy’.”
The solution? Let them die, safely.
The problem is, pulling the rug out from under them and letting companies collapse automatically would not end well.
“Imagine, for example, that all companies within a particular industry suddenly recognised that the pace of nominal economic expansion would not be sufficient to support their current cost base,” wrote King.
“Imagine, as a result, that there was a prolonged wave of restructuring, associated with mass layoffs. The result would be an even lower level of nominal output, triggering a further wave of restructuring — unless, that is, the restructuring led to significant productivity spillovers.”
The solution then is to allow this to happen, while also having the government come in as a large source of demand to make up for the sudden dropoff.
King suggests “a range of public works programs” to make up the gap.
So the essence of the argument is central banks and governments should let inefficient “zombie” companies burn, because whatever comes next will be a whole lot better.
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