A decade of the living dead
22 May 2018
The number of business insolvencies in the Eurozone has been declining since mid-2013, coinciding with the emergence of the single currency bloc from its double-dip recession (See Chart 6). The 30% plus decline in insolvencies over this period largely reflects the growing cyclical strength of the Eurozone recovery. Indeed, the number of insolvencies hasn’t been as low as it is now since the formation of the Eurozone; using national-level data, one has to go all the way back to 1994 to find a total insolvency count as low as it is now (insolvency rates are not available for most Eurozone economies). For the limited country-level data available, the biggest drop in insolvencies has been in the Netherlands, Spain and Germany – among the best-performing large Eurozone economies since the end of the debt crisis.
But there may be another cause of the Eurozone’s low business insolvency rate, with potentially less benign consequences. Inadequate insolvency regimes and an extended period of bank forbearance, particularly among the most troubled banks, may be keeping lenders from foreclosing on borrowers who have persistent difficulties meeting loan interest expenses. This is the so-called ‘zombie’ problem – the rise in the number of firms with interest expenses that exceed earnings before interest and taxes. The data are very patchy, but work by the OECD suggests that the share of firms that are ‘zombies’ under this definition has risen over the past decade in some, but by no means all, Eurozone member states. An increase in bank forbearance may be the result of poorly capitalised banks’ perverse incentives not to book losses, instead rolling over non-performing loans in the hope that they will eventually come good.
Some economists have posited a link between the rise of ‘zombie’ firms and weak Eurozone productivity growth. The Eurozone has certainly experienced a slowdown in productivity growth in the decade since the financial crisis, although this only extends a trend that was in place well before the crisis (See Chart 7). The argument is that lender forbearance and the rise of zombie firms has obstructed the ‘cleansing’ effect of recessions, with creative destruction via restructuring and productivity-enhancing capital reallocation not functioning properly. It certainly appears that the productivity gap between the most and least productive European firms has been widening, with some suggesting that laggard firms have limited incentive to adopt best practices from the frontier when they can limp on in their zombie state. Market ‘congestion’ generated by zombie incumbents may also create barriers to entry for potentially higher productivity firms – undead firms may inflate the pervading wage level, presenting new entrants with a higher profitability hurdle to clear before deciding to enter the market. All this comes under the rubric of ‘capital misallocation’, but we would also highlight the sustained period of aggregate demand weakness weighing on capital deepening, changes in the sectoral composition of the economy, a secular deceleration in the rate of technological progress, and possible measurement error, as other possible sources of the slowdown in Eurozone productivity growth.