How Fed-Enabled Zombie Companies Crush Productivity Growth

Authored by Catherine Mann and Dan Andrews, originally posted op-ed via,

When lagging firms don't go bust, they hog scarce resources and drag down productivity.

The global economy is picking up steam, but that’s deceptive. The foundations of expansion are soft, marked by weak productivity growth and inequality. The two are related.

The productivity problem confronting the world’s advanced economies predates the financial crisis more than a decade ago. When we look beyond the headline statistics, patterns emerge. Advanced economies have become less dynamic and are at risk of becoming sclerotic unless the ambition for reform is revived.

It’s essential that we understand three sources of the current productivity slump in particular, and identify the key reforms necessary to address them.

First, the productivity slowdown masks a widening performance gap between more productive and less productive firms, as the chart below shows (the picture for service sector firms is even worse). This divergence is not just driven by firms at the frontiers of their industry, pushing the technological boundaries, but also by stagnating productivity growth at what can be called laggard companies that have failed to adopt the leaders’ best practices. This is also bad news for inclusiveness, since rising wage inequality can be largely traced to the growing differentials in average wages paid across companies, with high-productivity ones paying high wages and low-productivity businesses paying low wages.



Second, in well-functioning markets we would expect strong incentives for productive companies to aggressively expand and drive out less productive ones. The opposite has happened. The propensity for high-productivity companies to expand and low-productivity companies to downsize or exit the market has declined over time. This pattern is evident in the U. S. and is particularly stark in southern Europe, where scarce capital has been increasingly misallocated to low-productivity firms.


Third, across the 35 countries in the Organization for Economic Cooperation and Development, we are seeing a drop in the dynamism of the business sector. Not only has the share of recent entrants into the market declined, but marginal companies, which would typically exit or be restructured in a competitive market, are more likely to remain. At the same time, the average productivity of these marginal businesses has fallen. In other words, it has become easier for weak companies that do not adopt the latest technologies to survive.

The survival of weak companies drags down average productivity, but the consequences for growth are even worse. Since such firms take up scarce resources, their prolonged survival (or their delayed restructuring) inflates wages relative to productivity, depresses market prices and undermines investment -- all of which deters the expansion of productive companies, particularly startups, and amplifies the mismatch of skills.

Today, the risk is that this phenomenon may contribute to a period of macroeconomic stagnation, as occurred in Japan during the 1990s. In Italy, for example, the share of the capital stock sunk in “zombie firms” -- old firms that have persistent trouble meeting their interest payments -- rose to 19 percent in 2013 from 7 percent in 2007. This growing market congestion due to zombie firms perhaps accounts for one-quarter of the post-crisis decline in business investment in Italy and is also a key factor behind the rise in capital misallocation.

Governments should focus on getting the basics right. This involves evaluating the conditions in product, labor, capital and housing markets to ensure that productive businesses can thrive, facilitate the restructuring of weak companies and enhance labor mobility so that workers can gain, too. The corollary is that governments should be modest about what selective or targeted interventions can achieve; even the most accomplished venture capitalists in Silicon Valley struggle to predict winners.

The sources of structural weakness in OECD productivity suggest that reform strategies should contain at least two mutually reinforcing elements, centered on companies and workers.

First, reforms that promote more efficient market entry and exit are vital. It’s no coincidence that laggard companies fell further behind the global productivity frontier in market services, where barriers to entry and competition remain high. And soon-to-be-released OECD research shows that scarce resources remain trapped in “zombie firms” partly because bankruptcy rules in many countries fail to facilitate restructuring or market exits in a timely fashion.


Second, policy measures to help workers adapt to technological change, and a more rapid churn of firms and jobs, are essential. Retraining and job-placement services are particularly effective at enabling a return to work for individuals displaced when their companies close. Such workers are typically older and have longer tenure at the firm compared with other displaced workers, making it harder for them to find new jobs.

Policies that accelerate creative destruction can have powerful effects on productivity, but can be politically contentious. But their political feasibility can be helped by policies which help laid-off workers find new jobs. And such labor market policies are more effective when regulatory barriers to entry and growth are low, because job opportunities are more abundant in places where innovative new firms can enter the market and grow.

There is no single fix to the productivity problem. But, over time, a strategy centered on encouraging innovation in firms, facilitating entries and exits from the market and helping workers retool can combat the structural weaknesses afflicting advanced market economies. Clearing the path for higher productivity growth is the surest way to ensure that economic expansion helps workers and doesn’t fizzle.