Money Matters

Beware the zombies behind the world’s productivity problem

Money Matters
By Martin Sandbu
Mon, 01, 17

The productivity debate rumbles on. As it must: the lack of productivity growth is one of the largest challenges our economies face. Without productivity improvements, other economic problems will be harder to solve, as even the best policies will, to some extent, amount to zero-sum games and therefore butt up against greater political resistance. When productivity grows faster, it is easier to spend on needed causes with less sacrifice from taxpayers, and to compensate losers from necessary reforms. And as Philip Coggan noted on Wednesday, the disappearance of productivity growth since the global financial crisis is not confined to rich countries. Indeed, the slowdown in the rate productivity advances has been more abrupt in emerging economies.

Both the European Central Bank’s Mario Draghi and the Bank of England’s Andy Haldane used their last speeches of 2016 to draw attention to the productivity problem. That was welcome. More welcome still is how both homed in on a particular feature of the problem. This is that productivity growth is not stuttering everywhere in the economy. In fact the best “frontier” companies are increasing their productivity as fast as before the financial crisis. The disappointing economy-wide productivity figures are to be blamed on the companies that are behind the frontier, and which seem to have got worse at picking up best practice from the productivity leaders.

This hugely important finding, that the diffusion of innovation and productivity growth from leading to lagging companies has slowed down, was first established by the OECD in the summer of 2015 (Free Lunch covered it then). It was high time for senior policymakers to address this, and indeed it is extraordinary that it took them this long. Draghi and Haldane deserve credit for applying the OECD findings to their respective economies. Draghi included this chart in his speech:

They show that the OECD finding is visible in the eurozone (where it is worse for services than for manufacturing) and the UK alike, and that its effect substantial.

If the slow productivity effect is linked to a worsening failure of middling companies to adopt innovation in productive techniques and know-how by the best, that has implications for the causes of this “broken technology diffusion machine”. In particular, it is unlikely that innovation itself has “run out”. Instead, something to do with the inability or unwillingness to make use of it is at work. In a follow-up post, Coggan refers us to a new OECD study that confirms his own suspicion: that what is at work are zombies!

By “zombies” are meant companies whose regular revenues at most cover their interest expenses (if that) - companies that, in Coggan’s words, “depend on the kindness of their creditors”. The OECD researchers find that such zombies take up a frighteningly large part of the economy. Across the nine European countries they studied, the share of the total private capital stock “sunk” in zombie companies ranges from 5 to 20 per cent. The suggestion is that such businesses hog capital and crowd the market for newcomers, make it harder for more promising companies to expand and hold back the reallocation of labour and capital to more productive and faster-growing companies. That is indeed the effect of “zombie congestion” the study identifies.

Why have zombies proliferated to such an extent? Awful economic growth environments are a big part of the cause, of course (Italy has the biggest zombie problem of the countries examined). But while poor growth explains poor business revenue, it is not sufficient to explain how such companies cheat death. The answer must be forbearance by creditors - typically banks that decide not to foreclose on bad loans.

Critics of loose monetary policy often complain that low interest rates have allowed bad businesses to stay in business. This is, at best, half-true. Higher interest rates would no doubt have flushed out the zombies - but they would have flushed out solid companies, too, as growth would have been even weaker or turned into reverse. But that does not entail the opposite; that low rates necessarily allow the zombies to live on. It is not the cost of borrowing that is at fault, but creditors’ willingness to tide over debtors who can barely meet even record-low interest service, let alone pay back the money they have borrowed. And the cause of that, in turn, is that governments have refrained from forcing banks to write down more decisively their own exposures to zombie companies.

Holding banks to proper account would have eliminated their reason for keeping zombies alive: once bad loans are fairly valued, a bank has nothing more to lose by realising that fair value. The effect of this would not just be to clean up banks, but to unblock credit flow to businesses that can do more with it. The failure to do this is the chief cause of the eurozone’s awful economic performance since 2008. No wonder it is Italy, which has dragged its feet the longest on its banking sector problems, that is the country most afflicted by zombie companies.