Yesterday’s Bank of England Inflation Report contained the grimmest medium term forecasts from the Bank since independence in 1997. It told of an economy set to experience only a weak recovery from the living standards squeeze, poor business investment and a prolonged productivity slump. It also seemed riddled with pessimism, suggesting there was little the Bank could do to boost growth. It was, in most regards, an economic horror show. So it is perhaps not surprising that a great deal of recent economic commentary is focussed on zombies.
The FT reported on Tuesday “Zombies seen to hold back recovery’”, Sky has “‘Zombie firms’: Mass unemployment warning”, whilst the BBC has run an article on “’Zombie’ companies eating away at economic growth” (itself a preview of an accompanying Radio 4 show).
The idea is that one key factor holding back the recovery is a series of demand and supply due to the existence of a large cohort of ‘zombie firms’ – firms that generate enough cash-flow to meet interest payments but little else. These firms, goes the theory, are clogging up bank balance sheets, unable to invest and ‘trapping’ workers in unproductive firms with a knock on impact on overall productivity. The argument relies on around one third of companies not currently being profitable whilst insolvencies are running at a much lower rate than in the early 1990s.
The argument is (at its most extreme) that policymakers’ response to the recession was too successful. Holding down interest rates prevented a steeper drop in GDP and a larger rise in unemployment but has now left us stuck with the economic equivalent of the undead, companies able to slowly shamble on but unable to properly grow and invest.
One major problem with this argument is where it naturally leads. If only, some will say, government and central banks hadn’t interfered so much with the economic cycle we would have had a nastier but shorter crisis. It sometimes sounds like people are urging central banks to adopt the role of depression era US Treasury Secretary Andrew Mellon with infamous call to:
liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.
I don’t think the central bankers should be casting themselves into the role of the Walking Dead’s Rick Grimes. Slaying the zombies by raising rates, as the FT’s Claire Jones & Chris Giles argue this morning, risks also “killing off viable businesses and grappling with the fallout from a rise in home repossessions”.
To my mind the low level of corporate insolvencies and the accompanying smaller rise in unemployment in the crisis than in previous economic catastrophes is a good thing.
As Lee Manning has written over at Accountancy Age, this may not be driven by the low rate environment but by the Enterprise Act of 2002 and the changes to the insolvency regime:
Rather than harp on about a low interest rate environment, HMRC’s tax deferral ‘Time to Pay’ scheme or a general reluctance to pull the plug by the banks, I would point to the now overlooked Enterprise Act, introduced ten years ago.
There is a broader point here, as Nicola has conclusively argued this morning, as for all the talk of ‘zombie companies’ in recent weeks, the Bank’s Inflation Report is nowhere near as conclusive on the issue as some of the commentary suggests.
My analysis of the Bank’s research is that it suggests both weak demand and underlying supply constraints are holding the recovery back – with the evidence suggesting that access to finance is the largest supply side problem, rather than large numbers of businesses operating with large debt overhangs. As repeated business surveys have shown it’s clear that access to credit is a real challenge to the recovery – and the needs for meaningful government action to resolve this issue and deliver a banking system that truly works for British business
The key challenge for the coalition is lifting the rate of growth of productivity, which has been stagnant. This means ensuring the flow of credit to businesses, so that they can invest. While the “Funding for Lending” scheme, which offers banks financial incentives to extend more credit to UK borrowers, may mitigate the problem, it will not solve it altogether.
The problem then is not so much one of ‘zombie firms’ that refuse to die but ‘a vampire banking system’ that isn’t supporting the recovery. The TUC has long argued the case for serious reform, as the general Council statement to congress this year concluded:
The banking system in the UK is not working and a watered down version of the ICB report combined with the Funding for Lending Scheme will not be enough to fix it. The TUC believes we need more fundamental reforms to how the financial system is structured, how corporate governance functions, to the type of banking institutions we have and to the variety of business models under which they operate. Only then can we begin to address the questions of how banks can support the real economy, how they can be made safer and how we can deal with excessive pay-outs to top staff.
Alphaville’s Izabella Kaminska (one the sharpest analysis of global finance) has argued that structural changes to the economy are changing banks behaviour, in a way very negative for the wider economy:
this could be because in a negative carry universe — one in which goods, collateral and assets are expected to permanently outnumber money in the future — bank profits can only be achieved through pariah practices rather than lending. Banks are ironically encouraged to destroy capacity, disincentivse investment, borrow money from the economy rather than lend it, and hoard wealth. All phenomenons we are currently seeing. All phenomenons which are economically destructive.
“Borrow money from the economy rather than lend it” – hence my description of a “vampire banking system”.
The Bank of England’s Andrew Haldane has spoken of a ‘great sucking sound’ as the banking system, if too large, drains resources from over sectors.
The costs of this great sucking sound are only now being properly understood. Recent research by the Bank for International Settlements suggests that, once bank assets exceed annual GDP in size, they begin to act as a drag on growth.
Why? Because human and financial resources are drained from elsewhere in the economy. The sectors hardest-hit by this financial vacuum-cleaner effect are R&D-intensive businesses (who might otherwise have attracted the scarce, skilled labour that flowed into finance) and businesses reliant on external funds (whose financial cake was instead being eaten by the banking system). These are the very businesses that today we are seeking to re-nurture.
So, if the problem is one of vampire banks rather than zombie companies, what can be done?
One answer is to rely on the ‘good banks’ (and as any pop-culture fan is aware there is of course precedent for ‘good vampires’ who reform their behaviour – my preferred models being Buffy’s Angel or Spike rather than Twilight’s Cullen family).
Haldane has been effusive in his praise for Sweden’s Handelsbanken which is expanding in the UK and follows a very different model from some of its competitors:
All credit decisions are taken locally by people, not centrally by a computer. No bonuses are paid and no-one has a sales-target. When the whole firm out-performs, a contribution is made to a pooled fund which is invested on employees’ behalf. The fruits of success are distributed equally and gratification is deferred.
But there is of course a limit to this. There are undoubtedly bits of the banking system that work better than others, but a hands-off approach from government will probabaly mean a continued dominance by the big existing banks.
The question for policymakers is how can they reshape the sector to encourage such behaviour – the banking system we have isn’t working, but we are not stuck with it. As today’s FT leader concluded:
Monetary and fiscal policy cannot alone end stagnation without more reform of the banking sector. How Mr Osborne plans to do this is more important than what he says about deficit cuts.
I’d like to see more ideas for how we deal with ‘vampire banks’ and less hand-wringing about ‘zombie companies’.