The financial markets have always responded enthusiastically to central banks’ highly accommodative policies of keeping rates very low and supplying astronomical, if not unlimited, amounts of liquidity to governments and businesses.
The central banks played a critical role in the market recovery after the Great Financial Crisis and during the coronavirus crisis: keeping short- and long-term sovereign rates at very low, if not negative, levels limited investors’ asset class choices, which led to higher prices on the equity markets.
Despite this short-term optimism, it might be useful to take a more nuanced look at this analysis and examine the long-term impacts of these policies on the real economy.
In more simple terms, these companies do not generate enough income to repay the interest on their debt.
This type of firm is also proliferating in liberal economies. According to Deutsche Bank’s estimates, one in five US companies is a zombie firm.[1] In OECD countries as a whole, this figure rose from 1% in 1990 to 12% in 2015 (Source: BIS).
So, as long as the low rate environment persists and the central banks buy up public and private debt, these companies will be able to borrow to preserve their existence.
The principle of creative destruction developed by Austrian economist Joseph Schumpeter holds that companies that are less efficient (in their management, production, innovation, financing, etc.) lose market share to more dynamic and efficient companies. Productivity gains are thus generated through product or process innovations, resulting in higher income for companies and employees.
This economic dynamism could be undermined by low rates: a company able to survive on infinite borrowing will not necessarily be incentivised to look for new ways to increase its profits. Ultimately, there is a real possibility that productivity gains will stagnate at the macroeconomic level.[2]
So what about capitalism’s ability to reinvent itself, to make way for more efficient, more innovative companies? Will these firms on life support be encouraged to innovate in order to achieve the productivity gains needed to sustain the improvements in standards of living the liberal economies are famous for?
[1] https://www.washingtonpost.com/business/2020/06/23/economy-debt-coronavirus-zombie-firms/
[2] Banerjee, Ryan, and Boris Hofmann. "The rise of zombie firms: causes and consequences." BIS Quarterly Review Spetember (2018).
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