Industrial policies mean cosseting losers as well as picking winners
Dawn of the living dead: zombie companies get a new lease on life
EQUITY markets have shrugged off the Brexit and Trump votes. Indices in London and New York have reached new highs. But individual stocks and industries have had the odd wobble, not least when they have been the subject of a hostile tweet from the incoming president.
“You’ve been fired at” may turn out to be a dominant meme of the next four years.
Indeed, what seems to be emerging on both sides of the Atlantic is a new version of industrial policy, in which Brexit negotiations, tax laws and trade talks are used as a way to favour some industries and punish others. And that ought to be cause for real investor concern.
The standard criticism of industrial policy is that it is all about “picking winners”. But the real problem is that it is more about protecting the position of established corporations—cosseting losers, in other words.
Which companies are most likely to get protected? The obvious answer is incumbent groups that possess lobbying clout. Many companies have expressed concern about Brexit, but it is to Nissan, a Japanese car giant, that the British government has made an undisclosed commitment. Startups are unlikely to be afforded the same courtesy. The danger is that this cements in place the existing structure of the corporate sector and prevents the emergence of more efficient firms that can drive forward productivity improvements. This has been called the “zombie company” phenomenon.
A new paper* from the OECD finds a link between the proportion of zombie firms surviving in an economy and declining productivity. Specifically, a 3.5% increase in the zombie share is associated with a 1.2% decline in labour productivity across industries.
The paper defines zombie firms as those aged ten years or older with an interest-coverage ratio (the ratio of operating income to interest expenses) of less than one in each of the preceding three years.
In a harsher age, their creditors might have finished them off. But today the zombies shuffle on, discouraging more efficient firms from investing and making it harder for rivals to earn increased profits and gain market share. Worse still, the decline in new business formation may be partly caused by the suffocating impact of zombies.
Europe, for example, often gets criticised for its economic inflexibility—particularly in the labour market, where the difficulty of firing workers makes companies reluctant to hire them in the first place. But the OECD study suggests that the problem of corporate ossification may be even more widespread.
The issue may also help to explain why the productivity performance of the global economy has been so disappointing. Figures released by the US Conference Board, a research group, earlier this month showed that total factor productivity (TFP) globally fell in 2015 and had been flat in the previous two years. (TFP is that element of growth that cannot be explained by the use of increased labour or capital.)
The new versions of industrial policy are likely only to exacerbate this problem. They look worryingly like the “Latin American” model of the 1960s and 1970s (ie, an import-substitution policy). If a company makes an investment decision on the back of a tax break or a threatening presidential tweet, then it is probably not making the most efficient use of its capital. It may seem like good news in the short term for the workers who keep their jobs. But it is not good in the long run.
The companies they work for will be less competitive in international markets; and, as consumers, workers will either pay higher prices or buy inferior goods. Instead of an inflexible labour market, you get an inflexible corporate market.
It all adds up to a double problem for equity investors. For now the market may be benefiting from a couple of sugar highs: in Britain, the impact of a falling pound on the overseas earnings of multinationals; and in America, the hopes for fiscal stimulus and lower corporate taxes. But in the long run, a more interventionist government policy is likely both to weigh on economic growth and to make equities riskier. Who knows, after all, which sectors will fall out of favour?
Imagine the reaction of investors if left-wing leaders were in charge. If President Bernie Sanders were berating American companies on Twitter, or Jeremy Corbyn was pledging unquantified British government support to manufacturers, markets would be plunging.
* “The Walking Dead: Zombie Firms and Productivity Performance in OECD Countries” by Mûge Adalet McGowan, Dan Andrews and Valentine Millot