Fear not the coming zombie apocalypse in the UK

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A harsh winter is coming to Britain, not only for the living but also for the living dead. Soaring borrowing costs generated by the short-lived Truss government could very well hasten a wave of liquidations among the country’s expanded corporate zombie population. The crisis, while painful for those who lose their jobs and see their investments fail, could ultimately prove an overdue tonic for a listless economy.

Zombies, a widely observed phenomenon first seen in Japan’s post-bubble era of 1990s, are debt-ridden companies with consistently low profitability and investment levels that earn just enough to stay in business. In normal times they can be expected to fail, although in depressed conditions they can be kept afloat by a combination of low interest rates, government fiscal support and banking forbearance. In the decade and a half of ultra-low rates following the global financial crisis, the Japanese experiment has proliferated, with academic research showing an increase in zombies across the world. The proportion rose to 15% in 2017 from 4% in the late 1980s, according to a Bank for International Settlements article that looked at listed nonfinancial companies in 14 advanced economies.

The UK has been hit harder than most, with government emergency loan schemes during the pandemic injecting a final spurt of growth into their ranks. Onward, a conservative think tank, estimates that an additional 1-4% of businesses have become “zombified” since March 2020, bringing the share to more than 20% of the total. When an entire economy is on life support, the undeserving and possibly unsalvageable people rise with healthy businesses that suffer only temporary distress.

A settlement appears to be at hand, however. Things were getting uglier even before the market turmoil of the past two months, as inflation prompted policymakers to normalize interest rates. A Bank of England measure of banks’ average financial costs for small and medium-sized businesses (which make up the majority of zombies) rose to 4.2% at the end of August, from a low of 1% in May 2020.

Over the past two quarters, business bankruptcies have been higher than their previous post-crisis peak reached in the first three months of 2012. Don’t be surprised if this number increases. The two-year sterling swap rate hit a high of 5.87% in late September, according to data compiled by Bloomberg. Although it is back to around 4.6%, it is still higher than before the ill-conceived package of unfunded tax cuts proposed by then Finance Minister Kwasi Kwarteng on September 23.

There are reasons to be optimistic about this process, however, at least to some degree. Zombie companies, it goes without saying, are a drag on the economy. They monopolize assets and workers that could be more productively employed elsewhere, driving up the costs of healthier businesses and causing misallocation of capital. A sign of dysfunction: UK unemployment is at its lowest in nearly half a century and a shortage of workers is driving up wages, despite an economy teetering on the brink of recession.

The harm caused by zombies is an idea intimately related to that of “creative destruction,” the term coined by Austrian economist Joseph Schumpeter in his 1942 book Capitalism, Socialism, and Democracy. The engine of capitalist innovation requires death as well as birth. It is a turbulent and painful process for those who lose their jobs, like the horse cart driver who is displaced by the development of the automobile. But the liquidation and redeployment of resources fuels a relentless progression of efficiency and value creation. Most of the time.

Ultimately, the price of money is the arbiter of what works and what doesn’t in a capitalist economy. It is axiomatic that a company that consistently earns less than its cost of capital is value-destroying, even if it is able to survive a low-growth existence and just get by. This is the consequence of prolonged depressed interest rates that tend to follow financial crises and the implosion of asset booms, such as in Japan and much of the developed world after 2008. When the bar is too low, everyone gets a pass.

The UK has been plagued by weak productivity growth since the financial crisis, which is the subject of much criticism from economists and policymakers. The growing prevalence of zombie companies may well have something to do with it. Returning interest rates to a more normal level that raises the bar for business survival has the potential to rekindle some of that lost economic momentum.

Certainly, the pace of the process is important. Too steep and abrupt a rise in financial costs would jeopardize many fundamentally sound businesses and threaten to plunge the economy into another prolonged slump, bringing the problem full circle. What constitutes a true zombie is also up for debate: raw metrics can capture start-ups or temporarily struggling businesses that have a good chance of thriving. Finnish researchers have found that one-third of zombie companies as they are commonly defined are growing and two-thirds are recovering to health.

Don’t mourn the loss of businesses stuck in perpetual funk that can’t survive without help, though. Within reason, the return of market discipline is a welcome development.

More from Bloomberg Opinion:

• Britain’s political stability won’t stop biting winter: Marcus Ashworth

• Five ideas for reshaping the future of capitalism: Adrian Wooldridge

• Credit markets are full of scares. Nobody Cares: Brian Chappatta

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Matthew Brooker is a Bloomberg Opinion columnist covering Asian finance and politics. A former editor and bureau chief of Bloomberg News and associate business editor of the South China Morning Post, he is a CFA charterholder.

More stories like this are available at bloomberg.com/opinion

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