Zombie firms are companies with insufficient revenue to cover their interest expenses. Companies are typically expected to innovate and restructure once they cannot service their debts or go out of business. However, zombie firms stagger as the undead, eating economic resources to keep operational. These firms feast on low interest rates and abnormally cheap credit while keeping themselves nominally functional for three years or more. Economists worry these firms will siphon resources from healthy parts of the economy, inhibiting productivity growth and lagging the post-crisis recovery (Hallak et al., 2018). Such concern is amplified as central banks steadily increase interest rates to stabilise inflationary pressures due to economic stimulus during the COVID-19 pandemic.

According to McGowan et al. (2018), zombie firms have gained prominence in high-income countries, such as those in the OECD, after they kept interest rates low since the 2008 global financial crisis. These firms occupy 15% of publicly traded companies in the US (2020) and 13% in the OECD (2013). Zombie firms are also responsible for 2.2 million US jobs (McGowan et al., 2018; US Congressional Research Service, 2020). Research on Japan during the 1990s, confirmed by the OECD study, shows that zombie firms increased barriers to entry and the likelihood of failure for new firms (Caballero et al., 2008). Moreover, economists argue that lenient monitoring can delay debt foreclosure to zombies, which enables them to continue operating with the bare minimum resources (McGowan et al., 2017).

Zombie firms respond sensitively to interest rates (Banerjee & Hofmann, 2018). Given the current economic turmoil, these firms might die as economic conditions change rapidly. Zombies getting out of business can create a wave of unemployment that might destabilise the aggregate economy. Understandably, there is a worry that collapsing zombie firms may shake the political and socio-economic landscape. Some may argue that zombies exiting the market is desirable. After all, the process of creative destruction, where new and more innovative firms replace the old and unproductive, is a given nature of the modern economy. What would happen if these zombies failed? Are zombie firms strong enough to take the shock from the changing economy? We will explore the topic in this article with the latest research on zombie firms and industrial organisations.

Characteristics and Risks

Two main characteristics of zombie firms are their size and age. These zombie firms are typically older and smaller than non-zombies in asset, capital stock, and employment (Banerjee & Hofmann, 2020; McGowan et al., 2018). Typically, zombie firms concentrate on labour-intensive industries such as mining and pharmaceuticals; they occupy a large part of the economy and are significantly more indebted than their non-zombie peers (Banerjee & Hofmann, 2020). Additionally, the price of killing a zombie is huge for the economy. When a zombie firm exits the market, it will decrease its former employee’s potential spending on goods and services that negatively impact economic output.

Collapsing labour-intensive companies, including zombie firms, expose socio-economic and political stability risks. Such risk is particularly relevant to countries with poor institutions that could not respond to signals of zombie firms’ collapse. Quoting the management consulting firm Begbies Traynor, Bloomberg reports that in the UK, the risk of business going bankrupt rose by more than a third in December 2022. The increased risk coincides with the Bank of England’s expansionary policy, leading to the highest interest rate in 14 years. This year saw the world economy trying to recover by increasing interest rates after price inflation ran high. Zombie firms in high-income countries who previously enjoyed cheap credit from extremely low-interest rates now face the risk of collapse, laying off most of their workers. We have started to observe an unemployment wave in 2023 in the tech sector, while the overall unemployment stays consistent with pre-pandemic levels in the US and the world (see: World Unemployment Figure 1991-2001).

The Unknowns

Current figures show that the economy has not seen any significant rise in unemployment and no news of major layoffs in labour-intensive industries. There are three possible reasons for this consistency in the labour market. First, firms may remain resilient with complete resources without worrying about massive layoffs, and zombie firms are dying without significant effect. Second, the unemployment crisis is still upon us, and what we see in the tech sector is the tail of what is to come. Third, firms may increasingly be zombified, keeping themselves nominally operational with debt despite the rising interest rates. Among these three plausible options, the third is the most dangerous. These newly zombified firms can make crisis recovery challenging, as more formidable zombie firms may not be easy to kill with conventional monetary policy.

Existing literature on zombie firms and industrial organisations has yet to explore this exciting topic. Our knowledge of zombie firms is limited to the few recent studies exploring their impact on high-income countries. An economist proposes pushing the economy above its potential by increasing interest rates and raising wages to move workers away from zombies, which is happening at present. However, the right way to kill zombies without straining the labour market is yet to be found. Moreover, the bias towards higher-income countries in the zombie firm literature left the lower-income countries unprepared to deal with the problem. What would be the best action to deal with zombie firms? Intervene and kill zombies outright or nurture them to recover? Would it be better to leave zombies at the mercy of market mechanisms? The gap in our knowledge left many questions unanswered.

Key Takeaway

We do know that zombie firms employ a smaller number of workers when compared to non-zombies, but they still hire a significant number of people in the economy. Failure of a zombie firm would lead to unemployment, and a healthy economy should allow these workers to move into more competitive firms. Current labour figures show that overall unemployment is still stable to its pre-pandemic level. No significant rise has been observed since the pandemic. Investigating whether zombie firms would significantly contribute to unemployment or are strong enough to take the 2023 interest rate hike is necessary. Knowing the problems zombie firms can cause, we must consider their risks to high- or low-income economies.

References

Banerjee, R., & Hofmann, B. (2018). The Rise of Zombie Firms: Causes and Consequences. BIS Quarterly Review, 67–78.

Banerjee, R., & Hofmann, B. (2020). Corporate Zombies: Anatomy and Life Cycle. In BIS Working Papers (No. 882; BIS Working Papers, Issue 882).

Caballero, R. J., Hoshi, T., & Kashyap, A. K. (2008). Zombie Lending and Depressed Restructuring in Japan. American Economic Review, 98(5), 1943–1977. doi.org/10.1257/aer.98.5.1943

Hallak, I., Harasztosi, P., & Schich, S. (2018). Fear the Walking Dead? Incidence and Effects of Zombie Firms in Europe. doi.org/10.2760/314636

McGowan, M. A., Andrews, D., & Millot, V. (2017). Insolvency Regimes, Zombie Firms and Capital Reallocation. OECD Economics Department Working Papers, 4(2), 10–18.

McGowan, M. A., Andrews, D., & Millot, V. (2018). The walking dead? Zombie firms and productivity performance in OECD countries. In OECD Working Papers (No. 1372; Vol. 33, Issue 96). doi.org/10.1093/epolic/eiy012

US Congressional Research Service. (2020, October 29). “Zombie” Companies: Background and Policy Issues. crsreports.congress.gov/product/pdf/IF/IF11673/2