Grade Booster student workshops are back in cinemas for 2022. Learn more

Economics

Student Videos

Zombie Firms

Level:
AS, A Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

What are zombie firms and why do they matter?

Bonus resource!

Download the PowerPoint for Zombie Firms

In this video we will be looking at the supposed rise of zombie firms in many advanced and emerging countries.

This is a key topic to be aware of as we head into a key phase for the global economy as it gradually staggers out of the covid pandemic.

Zombie Firms

What are zombie firms?

To what extent are there many zombie firms operating in the UK economy at present?

Much depends on how we define a zombie firm and indeed, there is no unique interpretation of what it means.

A zombie firm is unprofitable and unable to pay the interest payments due on their existing debts.

Some economists argue that the presence of zombie companies has increased markedly since the 1980s. Research published by Banerjee and Hoffman in a 2020 paper published by the Bank for International Settlements found that the share of zombie firms in public companies has climbed from 4% in the late 1980s to 17% in 2020.

Others argue that zombie firms account for only a very small percentage of total output and employment in a developed economy such as the UK or the USA. (After all, zombie firms tend to be smaller).

Observed characteristics of zombie firms

Recent research evidence finds that zombie firms tend to be

  1. Smaller - usually around 1/3rd the size of non-zombie firms
  2. Less dynamic with lower capital investment ad R&D spending
  3. Less productive – labour productivity tends to be around 1/2 of non-zombie peers in the same industry
  4. More leveraged - they tend to borrow a lot of money to get them through cash-flow problems (leverage is the ratio of debt to assets)

Why do zombie firms manage to survive?

  • They continue to manage access to external finance such as loans at cheap interest rates (this has been a decade or more of low borrowing costs). This allows them to roll-over their debts.
  • Banks may be reluctant to call in loans because they are vulnerable to the financial costs of bad debts / defaults.
  • They can tap into government financial support (state aid) such as state-guaranteed loans and the pandemic furlough scheme.

Some zombie corporations do die, others are taken over thorough merger and acquisition and some recover. But relatively few die through market exit.

Why does have zombie firms matter for the economy?

Is having a lag of zombie firms a problem for the performance of an economy?

  1. Zombie companies can hold back productivity growth which then impacts on LRAS and therefore a country’s trend growth rate
  2. Unprofitable zombie companies pay little tax in the form of corporation tax which impacts on the government’s budget deficit
  3. Zombie firms can restrict the dynamism of markets. The exit of firms creates possibilities for new suppliers to emerge and succeed
  4. Their borrowing from capital markets might cause some crowding-out of financial capital available for new businesses - capital can therefore be misallocated (a loss of allocative efficiency)

The Power of Creative Destruction, a recent book by economists Philippe Aghion, Celine Antonin and Simon Bunelargues that “constant innovation is the driving force of capitalism and the catalyst of long-term growth”. A key aspect of this is that weak companies are allowed to go bust, freeing up resources for companies which will use them more effectively. Zombie firms can hinder progress in achieving more dynamic efficiency which, in the longer term, is important in building and sustaining international competitiveness.

In 2022 with interest rates likely to rise to help combat rising inflation, it may well be that many firms, laden with heavy debts, will find it difficult to finance their way through the year. Expect the issue of zombie firms to remain one of growing interest to economists and policy-makers alike.

Boston House,
214 High Street,
Boston Spa,
West Yorkshire,
LS23 6AD

Tel: +44 0844 800 0085

© 2022 Tutor2u Limited. Company Reg no: 04489574. VAT reg no 816865400.