Zombie companies walk among us

Tim Harford in The Financial Times


For vampires, the weakness is garlic. For werewolves, it’s a silver bullet. And for zombies? Perhaps a rise in interest rates will do the trick. 

Economists have worried about “zombie companies” for decades. Timothy Taylor, editor of the Journal of Economic Perspectives, has followed a trail of references back to 1989, noting sightings of these zombies in Japan from the 1990s, and more recently in China. The fundamental concern is that there are companies which should be dead, yet continue to lumber on, ruining things for everyone. 

It’s a vivid metaphor — perhaps a little too vivid — and it is likely to be tested over the months and years to come if, as almost everyone expects, central banks continue to raise interest rates back to what veterans might describe as “normal”. 

Claudio Borio of the Bank for International Settlements recently gave a speech in which he worried about the tendency of low interest rates to sustain zombie companies. Mr Borio has consistently been concerned about the distorting effects of low interest rates, but the zombie element of his argument adds a new twist.

Researchers at both the BIS and the OECD, the club of wealthy nations, have found evidence that low interest rates seem conducive to the existence of zombies, which they define as older companies that don’t make enough money to service their debts. As interest rates have fallen around the world, such zombies have become more prevalent and have also shown more endurance. 

On average, across the US, Japan, Australia and western Europe, the proportion of firms that are zombies has risen fivefold since 1987, from 2 to 10 per cent. The zombies walk among us. 

Why should we worry? One obvious answer is that zombies absorb resources. If a zombie retailer occupies a space on the high street, that makes it harder and more expensive for a start-up or a successful competitor to move in. The same goes for any resource from advertising space to electricity, and of course it goes for staff, too. 

We would usually expect a thriving company to be able to outbid the walking dead for anything necessary, from a finance director to a unit in an industrial estate. But the status quo always has a certain power, and in some cases, the zombie might be at an unfair advantage. 

Consider a zombie bank, propped up by a government guarantee but basically insolvent. Gambling on resurrection, it tries to expand by offering high rates to depositors and cheap loans to creditors. In the late 1980s, Joseph Stiglitz — later to win a Nobel memorial prize in economics — proposed a “Gresham’s law” of savings-and-loan associations based on this tendency: bad associations crowd out good ones. 

More recently, the collapse of Carillion, a large British outsourcing and construction firm, showed a similar dynamic. The more Carillion struggled, the more desperate it became to win new business — which meant aggressive bids in competitive auctions, dooming Carillion while starving competitors of business. 

Having written an entire book about the importance of failure, I am naturally sympathetic to Mr Borio’s argument. Modern economies have a low failure rate — probably too low. Still, one should not be too cavalier about this point. To ordinary ears, bankruptcy sounds unambiguously bad. If you spend too much time thinking about zombie firms and economic dynamism, bankruptcy starts to sound unambiguously good. 

Cut down those zombies and let highly productive new firms grow in the rich soil, fertilised by those zombie corpses, sounds like — forgive the play on words — a no-brainer. But should we really be so pleased that so many of the UK’s coal mines, or the auto suppliers of Detroit, have been successfully killed off? If nothing has replaced them, there is nothing to celebrate. 

One of the lessons of recent economic research by economists David Autor, David Dorn and Gordon Hanson has been that productive new firms do not necessarily spring up as we might have hoped. Mr Autor and his colleagues have, in a series of influential papers, tracked local areas subject to the sudden shock of competition from imported Chinese products. Their conclusion: recovery is neither quick nor automatic. 

Nor is it always easy for laid-off workers to stroll into fresh jobs: if you have worked for several years stitching soft toys, then the obvious next step when the toy factory lays you off is to start stitching shirts or trousers instead. Unfortunately, that is also the obvious next move for the importers, or the robots. 

We can make a long list of policies that might help new productive firms to get started and expand: education, infrastructure, flexible regulations, small-business finance and so on. There is some evidence in favour of these policies, but no checklist can guarantee results. 

Still, that is where to focus our attention as the zombies start to expire. The easier it is to start a new idea, the more hard-nosed we can be about killing off the old ones. It is necessary that the zombies must die, but that cannot be where the story ends.

No one wins in modern-day academia

No one wins in modern-day academiaNick Cohen The Observer, Sunday June 8 2008 Article historySt Matthew's warning that 'unto everyone that hath shall be given, and he shall have abundance: but from him that hath not shall be taken away' is the biblical quote least likely to stir the Labour soul.

That the rich get richer and the poor will get poorer is not a policy prescription that appeals to the left. With the best of intentions, however, Labour is imposing the Gospel according to St Matthew on England's universities and is providing a parable on the state of the nation in the process.

Few dispute that academia needs reforming. Britain has a university system in which the last measure the government uses to judge the quality of academics is their ability to teach. Instead, tortuous bureaucracies assess the merits of the research produced by every department in all the 200 universities. On their ruling rests the disposal of £5bn of public money.

The 2008 fight for loot is under way. Luckless workers at a Bristol warehouse are sending 200,000 scholarly books and papers to the 1,000 or so professors who adjudicate on 70 panels like the judges of beauty contests.

In the inaugural issue of the new magazine Standpoint, Jonathan Bate of Warwick University despairs of the absurdity of the enterprise. He explains that panels filled with professors of foreign languages have been more generous in rating the work of their peers than professors of English. Officially, our universities are now world leaders in the study of French literature but awful at studying English literature. What's really happened, says Bate, is that while other professors of literature covered each other's backs and looked after each other's departments 'the Eng lit lot couldn't resist biting each other's backs' even if it meant their subject lost money.

Neither he nor the government says this, but a second failing of the system is that it creates conformism in supposedly independent minds. There are many honourable exceptions, but as a herd, academics are the most predictable of beasts. If I sit down with builders, dentists or accountants, I have no way of knowing what their opinions will be. Within seconds of talking to an academic, I guess their views on every major political issue.

Why should I be surprised? To get the academic papers published the judging panels demand, lecturers must engage in the soul-destroying task of sucking up to the editors of learned journals. The funding for their departments and their very livelihoods depend on their ability to please. The government does not ask researchers to produce work of intellectual distinction, however long it takes. They must loyally churn out enough papers to allow their department to claim a slice of the booty.

The government admits this can't go on. It plans to replace the judging panels with a computer, which will record the number of times an academic's name is mentioned by his colleagues. The theory is that the best academics receive the greatest number of acknowledgements in footnotes. Let a database identify who these oft-cited professors are and - bingo! - you have found the finest minds of your generation.

Ministers possibly realised that under the present funding arrangements, Cambridge University would have to sack Ludwig Wittgenstein. He might have been a genius, but it took him decades to produce a book. Under their new system, the thousands of academics who quoted his work would provide a true assessment of Wittgenstein's worth and spare him the dole.

It sounds fair until you remember St Matthew. In 1968, Robert K Merton of Columbia University coined the phrase 'the Matthew effect' when he looked at how scientists valued each other. He found that the already eminent got disproportionate credit for their work while unknowns, whose research was often as valuable, struggled for recognition.

The great English geneticist JBS Haldane illustrated Merton's argument with the story of an Indian student, SK Roy, who had found a way to improve strains of rice. 'I thought it was a rather ill-planned experiment,' Haldane admitted, 'but I let him go ahead on the general principle that I am not omniscient.' The experiment was a triumph. Haldane said that Roy deserved 95 per cent of the credit, but would never get it. 'Every effort will be made here to crab his work. He has not got a PhD or even a first-class MSc. So either the research is no good or I did it.'

Beyond the prestige of quoting established names lies the incentive to cheat - academics are already promising that 'if you cite my research I'll cite yours' - and beyond that lies sheer luck. Nassim Nicholas Taleb, who glories in the title of professor in the sciences of uncertainty, points out that what leads to one academic being cited rather than another can be a simple fluke. But as soon as he or she is cited in one paper, the odds increase that he or she will be cited in another.

The Matthew effect does not only work in academia. Of the thousands of first novels each year, the few that are reviewed make the literary pages because the author is already well known in another field (prestige), the author is a friend of the literary editor (cheating) or the author's book was picked at random from a pile on a slow week (luck).

City firms give lavish bonuses because they don't want to lose staff to rivals (prestige), because they dealt on insider information (cheating) or because they pulled out of the sub-prime market just in time (luck).

You only have to read the financial press to know that the beneficiaries of the property crash won't be first-time buyers - they are struggling to get mortgages because of the credit crunch. The winners will be the already rich sitting on piles of cash who will snap up assets when their prices hit the floor.

Labour should not be happy with helping those that hath. If it wants to reform education, it should begin by noticing that working-class students are dropping out and middle-class students are paying fees for substandard courses, because the first concern of the universities isn't teaching. Ministers would do better to redirect public money to make sure that it is.