A rise in so-called “zombie firms,” alongside higher interest rates, has led several experts to warn of the impact it could have on employment in developed nations.
Zombie firms, as they are often called, are companies that would have defaulted in a normal economic cycle but continue to function due to an ultra-low interest rate environment.
“Like the characters after which they are named, zombie firms are creatures that really should have shuffled off to the next realm some time ago. Instead of embracing death, they soldier on, usually wreaking havoc on the rest of society,” Eoin Murray, head of investment at Hermes Investment Management, said in a research note Wednesday.
Economists define a zombie firm as one which is at least 10 years old but is unable to cover its costs with its profits. Murray described collapsed facilities management and construction services company Carillion as one. Ever since the financial crisis, these firms have taken on huge pile of debts as borrowing became so cheap on the back of low interest rates.
The numbers of such firms are currently on the rise, according to a report from the Bank of International Settlements (BIS) released last month.
Low interest rates
Decades of falling interest rates have led to a sharp increase in the number of zombie firms that are potentially threatening economic growth and preventing interest rates from rising, the report stated.
“Our analysis suggests that this increase is linked to reduced financial pressure, which in turn seems to reflect in part the effects of lower interest rates,” the research said, adding that these “zombies” weigh on economic performance because they are “less productive and because their presence lowers investment in and employment at more productive firms.”
The BIS, known as the central bank of central banks, states that the fragility of these companies puts policymakers across the world in a rather tricky position as a rate hiking cycle could kill many of these companies, triggering significant unemployment.
Zombies on the rise
According to BIS, the prevalence of zombie firms has ratcheted up since the late 1980s. In its research across 14 advanced economies, the BIS found the share of zombie firms had gone up, on average, from around 2 percent to 12 percent in 2016.
Similar research carried out by the Organisation for Economic Co-operation and Development (OECD) late last year showed the prevalence of these firms had risen since the mid-2000s in a number of developed economies.
Claudio Borio, head of the monetary and economic department at the BIS, in a speech earlier this year said that zombies have been on the rise and have been surviving for longer periods of time. Citing OECD data, Borio said that in 1987, the probability of a zombie firm remaining a zombie in the following year was approximately 40 percent. This has gone up to 65 percent as of 2016.
Deutsche Bank, in a research paper on the rise of zombie firms in March this year, discussed the persistence of these walking-dead firms and attributed them to a decade of super-low interest rates.
“Bottom-up data of some 3,000 companies in the FTSE All World index show that the percentage of zombie firms has more than tripled to 2.0 percent of firms in 2016 from 0.6 percent in 1996,” the bank said.
Rates going up
With central banks across the world on a rate-rising path, zombie firms are being put at risk. But it is a “difficult trade-off,” according to the BIS.
While lower rates boost aggregate demand and raise employment and investment in the short run, more zombies in the economy could continue to put pressure on productivity and growth.
“A recession could be on its way,” Hermes’ Murray said, adding that while it will impose some pain on innocent bystanders, it could help deal with the problem of zombie firms.
The bigger risk, however, is how this impacts the labor market and its impact on the fundamentals of the global economy. Murray explained that when interest rates start to rise, the immediate impact will be felt in the labor market, but suggested it could have a positive effect over the longer term.