Corporate Insolvencies: Two Charts
The Bank of England’s Chief Economist has given a very hawkish speech warning that the output gap may be much smaller than many assume and that further stimulus could lead to higher inflation. As Philip Inman reports:
Spencer Dale said with little slack in the economy, businesses would put up prices if extra quantitative easing (QE) found its way into consumers’ pockets. “The argument that it is possible to grow the economy without much increase in inflation is seductive and enticing,” he said. “It’s like being offered a free lunch.”
There is much to dispute in his analysis (see for example the most recent TUC work on productivity and the output gap) but I wanted to focus on one line of his remarks.
Likewise, the surge in corporate insolvencies and associated increase in capital scrapping seen in the early 90s has not been repeated
This line was accompanied by a now familiar chart:
As I argued before I simply don’t have a huge amount of time for this argument that ‘zombie companies’ which should have failed are holding back the economy. The evidence for the widespread existence of such firms usually comes from some version of the chart above and argument that corporate insolvencies didn’t hit early 1990s levels in the recession and this is down to low interest rates and some form of forbearance from lenders.
What this analysis misses is the Enterprise Act 2002 which came into force in 2003 and made huge changes in the UK’s insolvency regime. As an article in Accountancy Age explained last year:
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.
Indeed when the Bank of England first used a version of the above chart in the November 2012 Inflation Report, it noted that:
Changes to legislation, data sources and methods of compilation mean the statistics should not be treated as a continuous and consistent time series. Since the Enterprise Act 2002, a number of administrations have subsequently converted to creditors’ voluntary liquidations. These liquidations are excluded from both the headline figures published by The Insolvency Service and the chart.
This, I would contend, is quite an important caveat when looking at corporate insolvency rates.
In fact I think the only safe way to show the chart is with the amendments made below:
If one were to look at the data post 2003 and the regime change, then quite a different picture emerges – insolvencies did pick up during the recession, fell back as the economy recovered and have settled at a higher but stable rate as the economy has stagnated.
Looking at corporate insolvency rates is no doubt a useful indicator, but one has to be very careful when comparing recent experience to that under a very different legal framework.