UK: Deloitte Monday Briefing: Zombie Companies

Last Updated: 4 December 2012
Article by Ian Stewart

Most Read Contributor in UK, August 2017

* In the last few weeks some commentators have suggested that the UK economy is being held back by so-called "zombie companies". These are weak, possibly loss making companies, which are able to survive thanks to low interest rates and a supposedly more tolerant attitude to corporate borrowers on the part of banks.

* The argument runs that if these zombie companies were allowed to fail, more productive businesses would fill the gap, leading to a more efficient allocation of resources. To its advocates this sort of creative destruction makes way for the strong businesses of the future.

* The investor Jon Moulton, head of Better Capital, has been a prominent exponent of the zombie company argument. He recently told the Financial Times that "[t]he vast majority of companies we look at with financial problems we never get the chance to invest in because banks will forbear, sort them out, given them a few bob."

* It is impossible to prove that weaker companies are holding back the recovery. But some data are consistent with this theory. Despite a deep downturn corporate insolvencies have remained remarkably low in recent years. Roughly a third of UK companies are now making a loss, a higher rate than the economy experienced in the 1990s recession. UK productivity growth has also been disappointingly weak, something which might, in part, be explained by the poor performance of zombie companies.

* The idea of zombie companies is not new. Economists of the 'Austrian School' champion the notion that recessions clear out unproductive capacity and create space for new, more efficient companies. Joseph Schumpeter's coined the phrase "creative destruction" to describe this process.

* During the Great Depression the US Treasury Secretary, Paul Mellon, made perhaps the most infamous statement on the subject, advising President Hoover to "liquidate labour, liquidate stocks, liquidate farmers, liquidate real will purge the rottenness out of the system. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less enterprising people."

* The failure of Japanese banks to foreclose on unprofitable and highly-indebted firms in the late 1980s recession is seen by some as contributing to two decades of weak growth.

* The central problem with the zombie companies argument is that it is difficult to distinguish between unviable businesses and those which, nursed through a downturn, would have a bright future.

* The main weapon in countering the financial crisis and recession has been low interest rates. It may be that one result of current, ultra low levels of interest rates is that some unviable companies are able to survive for longer. Yet this does not prove that low interest rates or forbearance on the part of banks is an inappropriate response to the crisis.

* As Spencer Dale, chief economist at the Bank of England, recently noted, it is "the whole point of monetary to keep companies that have a viable long-term future in business while demand is temporarily weak."

* The willingness of banks to nurse companies through tough times is surely predicated on a view that a business has a long term future. Banks seem better best placed than, for instance, government, to judge whether a business is viable.

* More generally all economic policies which aim to bolster demand have unavoidable and unwanted side effects. Low interest and quantitative easing rates hit savers. Increasing government spending adds to the debt burden faced by future generations. Nationalising banks transfers private risk to the public sector.

* Killing off zombie companies by raising interest rates would have huge, unwanted side effects - raising debt servicing costs for consumers and corporates; hitting confidence and depressing demand. The Bank of England estimates that a one percentage point rise in interest rates that lasts for one year leads depresses GDP by up to 0.35% of GDP after five quarters.

* The medicine would risk killing the patient. The aim of current macroeconomic policies is to keep businesses going through an exceptionally difficult period. The hope is that, in time, many of these zombie companies will be able to 'rise from the dead'.


UK's FTSE 100 ended the up 3.8%, the best weekly performance of 2012.

Here are some recent news stories that caught our eye as reflecting key economic themes:


* Ratings agency Moody's downgraded France's credit rating, from AAA to AA1, citing the country's "sustained loss of competitiveness" – France

* French car-maker Renault announced plans to create 1,300 jobs in Valladolid, Spain, to build two new vehicle platforms citing the "competitive performance" of the workforce – competitiveness

* Net borrowing by nonfinancial businesses in the UK rose by £247m in October, following on from a £991m net repayment in September, according to data from the British Bankers' Association – bank lending

* UK public sector net borrowing, excluding financial interventions, rose to a higher-than-expected £8.6bn in October, hit by a 10% fall in corporation tax receipts and a rise in day-to-day departmental spending – government borrowing

* Mario Monti, the Italian prime minister, claimed that "Perhaps today, without the austerity measures brought in by the government, the eurozone would be no more" – euro crisis politics

* US bond investor Frank Templeton Funds increased their holdings of Irish bonds by more than a third in Q3 2012, holding nearly 10% of Ireland's total government bond market – search for returns

* Trading of US equities on "dark pools" – which allow investors to trade blocks of shares anonymously – has risen by almost 50% in the last 3 years, according to data from the CFA Institute – dark pools

* Qatar signed a deal with Italy's state investment fund aimed at investing up to €2bn in Italian companies over the next four years – foreign investment

* Greek prime minister Antonis Samaras is to visit Qatar on November 27th "with the aim of attracting investors", according to Greek government officials – foreign investment

* More than 1 in 10 shops in UK town centres were vacant in October according to survey data from the British Retail Consortium – high-street spending

* Bad debts at Spanish banks reached €182bn in September, representing 10.7% of total assets, according to data from the European Central Bank – banking stress

* China's HSBC Purchasing Managers Index (PMI) recorded its third consecutive increase in November and recorded the first expansionary reading since October 2011 – China

* Japanese exports to China – its largest export market – fell by an annual rate of 11.6% in October, hit by a Chinese consumer boycott of Japanese goods following diplomatic tensions – Japan

* Eurozone consumer confidence reached a 3 and half year low in November, according to survey data from the European Commission – slowdown

* US sales of previously owned homes rose by 2.1% in October from September, according to data from the National Association of Realtors (NAR) – US housing

* Officials in Crescent City, California, are spending $54m to build the West Coast's first harbor able to withstand the kind of tsunami expected to hit once every 50 years – disaster preparedness

* Budget airline Easyjet announced record pre-tax profits of £317m for the year to 30 September, helped by flying more profitable routes – Easyjet

* Tesco magazine achieved a readership of 7.22m in the year to September, making it Britain's most-read publication, according to data from the National Readership Survey (NRS) – Tesco

* Hostess Brands, the maker of Twinkies – a cream-filled sponge cake – announced that it is to close the company, leading to the loss of 18,500 jobs – Twinkies

* Greek police arrested a 35-year old computer programmer suspected of stealing the personal data of roughly two thirds of the country's population – data protection

* A group of around 200 independent traders and street hawkers in East London have come together to form a 'medieval' trader's guild – called the East End Trades Guild – in order to combat rising rents – collective bargaining

* Iconix Brand Group sold $600m of bonds backed by the revenues from its portfolio of brands, which include the Peanuts cartoon strip – Snoopy securitisations

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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