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Who's afraid of zombie firms?



The COVID-19 pandemic has turned many profitable US businesses into money-losers that can stay afloat only because of abundant credit, in part reflecting emergency lending programs of the Federal Reserve and Treasury. Some economists are concerned that these “zombie” firms will drain resources from the healthy parts of the US economy, slow the recovery, and inhibit productivity growth. These fears are fundamentally misguided. Zombies are a consequence of a weak economy, not a cause. Policy actions to kill zombies, by forcing them to shut down permanently, dismiss employees and pay off creditors, risk deepening the current recession, turning it into a depression.

According to the Washington Post, quoting Deutsche Bank Securities, nearly one in every five publicly traded US companies is a zombie—double the number since 2013. The Postand The Economistsummarize the case for concern about growing numbers of zombie firms.[1] Research on Japan in the 1990s shows that the presence of zombie firms in an industry makes it harder for the nonzombie firms to grow. It is argued that flaws in bankruptcy procedures and financial supervision cause banks and other creditors to delay foreclosure of nonperforming loans to zombies, enabling them to continue operating as long as they can pay their workers. The implication is that better regulation would hasten the demise of zombies and allow their more efficient competitors to take over, boosting overall economic growth.

The problem with this prescription is that it assumes the economy always operates near its potential and that macroeconomic policy acts forcefully to keep it that way. The lesson of the past 20 years, especially in Japan, is that this assumption is deeply flawed.

Costs of killing zombie firms are huge in an economy operating below potential

When the economy is operating below potential and the forces returning it toward potential are absent or weak, the costs of killing zombie firms are huge. Killing a zombie immediately wipes out the income its workers have to spend on goods and services throughout the economy. This decline in spending drags GDP down by potentially more than 100 percent of what the zombie firm used to produce via a Keynesian multiplier effect.

The potential gains from killing zombies stem from the space created for more efficient competitors and new entrants to grow. Studies show that increases in industry productivity from major trade liberalizations (which led to wholesale entry and exit of firms) are on the order of 10 to 20 percent. If efficient competitors could take over the entirety of a zombie’s sales, economywide income could rise by 10 to 20 percent of what the zombie used to produce. However, this growth takes time as firms make plans to hire new workers and install the capital they need. Thus, killing a zombie firm when the economy is operating well below potential causes an immediate drop in GDP on the order of 100 percent (or more) of the zombie’s production, which is only gradually offset by eventual improvements in productivity amounting to a small fraction of the lost GDP.

When the economy is operating below potential, many firms operate at a loss. In such an environment, central banks set interest rates close to zero, and it costs creditors little to keep loss-making firms in operation in hopes of renewed profitability when the economy recovers. There is nothing wrong with this outcome. Indeed, to some extent, it is the goal of monetary policy in a deep recession. Given the uncertainty surrounding the structure of the postpandemic economy, it is all the more important to keep unprofitable firms alive now in case demand for their products and services rebounds later.

The right way to kill zombies is to push the economy above potential, raising wages and interest rates higher than zombies can afford to pay. In this environment, workers let go by zombies quickly move to more competitive firms, boosting productivity and growth for all.


1. There are different views on how to define a zombie. A common definition is a firm whose cash flow is insufficient to cover its interest expense, necessitating an increase in debt. Economic slowdowns greatly increase the number of firms that meet this criterion, suggesting a better definition may take into consideration the likelihood that a firm will be able to repay its debts when the economy returns to normal. Using a somewhat different definition, this study shows that the COVID-19 recession has the potential to vastly increase the number of zombie firms, at least temporarily.

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