Zombies must not stand in the way of the economic recovery

Research report

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Massive government interventions have significantly mitigated the economic damage of the Covid-19 crisis to families and businesses. The collateral damage of this was probably the fact that support also went to so-called zombie companies. As freedom-restricting measures to contain the Covid-19 virus are lifted, emergency economic aid must also be stopped, or at least become highly selective. Keeping zombies going should be avoided at all costs, as they have been hampering economic growth for a long time and would hamper the planned structural economic transformation. They also threaten to prematurely stifle the economic recovery, as labour shortages are already emerging. The recovery requires a form of creative destruction, in which unviable companies make way for companies that profitably and sustainably meet new needs. To this end, the competitive framework must be restored and strengthened, and supplemented by the principles of flexicurity: the combination of flexible labour markets, a sufficiently high level of income protection and an active labour market policy, flanked by (lifelong) learning that promotes people's employability.


During the Covid-19 crisis, the government spent money on an unprecedented scale to minimise the economic damage to families and businesses. One of the aims of the measures was to prevent viable businesses from disappearing due to the exceptional circumstances. Companies that were already no longer financially viable before the outbreak of the pandemic would, in principle, not have access to the aid. In this context, zombie companies are often mentioned. But what are they?

There is no single definition of zombie companies. Simply and intuitively put, they are companies that are not viable today nor in the future and do not have sufficient financial buffers of their own. They stay alive artificially, thanks to, among other things, a permanent credit infusion. Economically, they are characterised by a high degree of debt and low solvency. In addition, they have poor profitability and invest little. They use scarce economic resources inefficiently.

Zombies have been around for a long time. The Bank for International Settlements (Banerjee, R., et al., 2018) notes an increase since the late 1980s among listed companies in 14 developed economies. The latest ECB Stability Report, based on a much broader sample of euro area non-financial corporations, shows that their share in the euro area in 2019 was still higher than before the 2008-2009 recession.1  Especially striking is the very large number of quasi-zombies—companies in the twilight zone of being at risk of possibly being zombies. (Figure 1).

Collateral damage

In order to prevent zombie companies from receiving public support, the European Commission had set criteria that governments had to respect when designing guarantee schemes and debt moratoria for companies. The aforementioned ECB analysis suggests, however, that these criteria have not prevented zombie companies from becoming eligible. To what extent these firms actually borrowed from these schemes cannot be determined.

But it is very likely that some have survived thanks to the emergency policy, if only because they benefit even more than financially sound companies (and borrowing households) from the low interest rates resulting from the ECB's flexible monetary policy—a policy that, incidentally, has been helping to preserve zombies' chances of survival since long before the pandemic. Because bankruptcy procedures were suspended in many countries during the pandemic, the number of bankruptcies in the crisis year 2020 was even significantly lower than in 2019.

The fact that less viable companies were also supported was of minor importance in the first phase of the crisis, and probably inevitable, given the high proportion of companies in the twilight zone and the exceptional circumstances of the pandemic. This made it practically very difficult to distinguish quickly and in real time between viable and non-viable companies.

Support for zombie companies is the collateral damage of measures that were absolutely necessary to prevent healthy, viable companies from getting into trouble because of the lockdown measures. Excessive bankruptcies and rampant unemployment would have exacerbated the economic malaise and made it difficult to restart the economy after the lockdowns. Systems of temporary unemployment helped prevent the disruption of high-performing businesses, which would have made the post-pandemic restart more difficult.

Need for creative destruction

However, as the recovery gets underway, the challenges and priorities change. There is a fairly broad consensus in Europe that recovery policies should make the economy more resilient, sustainable, and digital. The Next Generation EU Investment Programme aims to be an important lever in this regard. This implies that economic recovery will have to be accompanied by structural changes. Former activities will have to be done differently or scaled down and new ones will have to be developed. For that matter, the pandemic itself has probably caused some lasting changes in consumer behaviour. This is another reason why companies have to adapt their business models, new companies may emerge, and others will disappear.

This means that a certain degree of so-called 'creative destruction' is imminent. Old, unprofitable activities and businesses will disappear. This frees up workers and capital for the development of new, more productive activities. That process is the engine of welfare growth.

The maintenance of zombie companies stands in the way of this process and thus impedes the growth of prosperity. Zombie firms are regularly cited as an explanation for the economic stagnation in Japan in the 1990s. OECD research (Adalet McGowan, M., et al., 2017) based on (mainly) European firms in the period 2003-2013 shows that the presence of zombie firms in a given sector not only hinders the creation of new firms, but also the growth potential of new entrants. The larger their share in a sector, the less other firms invest and create jobs, and the fewer productivity gains are realised. In macroeconomic terms, this results in weaker welfare growth. Other OECD figures suggest that in the years following the global financial crisis, zombification has occurred relatively more in polluting industries. Thus, maintaining zombified industries could also become an obstacle to achieving environmental goals.2

As economies reopen, viable firms must continue without government support and policies may no longer support non-viable firms. Theoretically, recessions are periods when creative destruction gets a boost. But the increase of zombie companies in recent decades suggests that recent recessions have triggered it less.

Keeping the Covid-19 support in place for too long would further stifle creative destruction by distorting normal competitive conditions. Therefore, support measures should be discontinued or at least made highly selective. The competitive framework should not only be restored but also improved, as the increase in the number of zombie companies before the pandemic indicates the need for this.

This is necessary not only because of the structural economic challenges, but also for the continuation of the economic recovery. Indeed, it is striking how early in the recovery companies signal labour shortages. The pandemic has clearly not eliminated the war for talent—a labour shortage predicted long before the pandemic. Keeping workers employed in unproductive zombie companies has a welfare cost today more than ever.

New wine requires new wineskins...

The new challenges require adapted policies. The OECD's annual Going for Growth report provides an overview of the desired measures to raise the economic growth potential. In the recent report, creative destruction features prominently.  In developed economies, the most common recommendations concern the regulation of product markets, competition, and free trade. In Belgium, these include the need to simplify various administrative provisions—particularly for start-ups—and to facilitate market access for some professional service providers. The recent Article IV report of the IMF to Belgium concurs with those recommendations. 

The stubborn survival of zombie companies in many countries is also linked to inefficiencies in bankruptcy legislation. Despite the recent revision, according to the OECD and the IMF, optimisations are still possible in this area in Belgium, especially with regard to SMEs.

Creative destruction requires flexible labour markets. High costs of dismissing employees, rigid wage-setting, and high charges on labour make the (re)allocation of labour difficult. It has been known for decades that Belgium also has work to do in this area.

... and an appropriate 'degustation' framework

Facilitating economic restructuring means reducing some protective measures. This is a tricky point because restructuring is often not a bed of roses. Moreover, the Covid-19 crisis has highlighted the (also economic) importance of socio-economic protection. However, with an appropriate policy, the restructuring pains can be made more palatable.

One of the lessons from the 2011 euro crisis is that drastic fiscal consolidation and structural economic reforms are difficult to reconcile. Structural reforms pay off most when they are supported by monetary and fiscal policies (Borbon, A.R., et al., 2016). In that respect, the investments planned in the context of Next Generation EU (NGEU) today already create a better context for structural reforms than the context of a decade ago, when severe fiscal austerity hampered economic growth in the euro area. When the European finance ministers update the European fiscal framework in the near future, they should keep this lesson in mind. At the same time, they will have to ensure the rigorous implementation of national recovery and resilience plans. These define the reforms to be carried out in exchange for the NGEU support.

The adjustment pains of structural reforms can also be mitigated by combining the phasing out of some protective measures with the strengthening of measures that promote people's reintegration in the economy. OECD research (Andrew, D. & Saia, A., 2016) suggests that policies can facilitate creative destruction by increasing support to laid-off workers. Workers whose employer goes bankrupt find new jobs more easily as spending on active labour market policies increases, offset by a corresponding decrease in passive measures.

The winding-up of unprofitable firms need not then end in long-term unemployment for the workers affected. On the contrary, it can contribute to solving the labour shortage and the mismatch on the labour market.

Strengthening active labour market policies is therefore a priority for 17 of the 37 OECD countries, including Belgium, according to the OECD Going for Growth Report. The IMF repeats this recommendation in the recent Article IV report for Belgium. It includes lifelong learning, which the IMF, incidentally, points out must address not only the long-standing shortage of STEM (science, technology, engineering, mathematics) skills in Belgium, but also the emerging shortage of low-skilled workers.

The combination of flexible labour markets, a sufficiently high degree of income protection and active labour market policies, flanked by (lifelong) learning that promotes employability, is known as the golden triangle of flexicurity. In the 'Five Presidents' Report on Completing EMU' (2015), the concept was still seen as a tool to strengthen convergence in Europe. It remains a useful guide to the post-Covid-19 challenges.

1 The ECB analysis considers a company to be a zombie company if it meets each of these three criteria for two consecutive years: 1) a negative return on assets (ratio of net income to total assets), 2) a limited capacity to service debt (a ratio of less than 5% between earnings before interest payments, taxes, depreciation and amortisation on the one hand, and financial debt on the other hand, and 3) negative net investment (annual change in total fixed assets). 

2 A recent NBER paper (Archarya, V., et al., 2020) also makes the connection between zombie companies and the too low inflation in European countries in recent years. 


Any opinion expressed in this publication represents the personal opinion by the author(s). Neither the degree to which the hypotheses, risks and forecasts contained in this report reflect market expectations, nor their effective chances of realisation can be guaranteed. Any forecasts are indicative. The information contained in this publication is general in nature and for information purposes only. It may not be considered as investment advice. Sustainability is part of the overall business strategy of KBC Group NV (see https://www.kbc.com/en/corporate-sustainability.html). We take this strategy into account when choosing topics for our publications, but a thorough analysis of economic and financial developments requires discussing a wider variety of topics. This publication cannot be considered as ‘investment research’ as described in the law and regulations concerning the markets for financial instruments. Any transfer, distribution or reproduction in any form or means of information is prohibited without the express prior written consent of KBC Group NV. KBC cannot be held responsible for the accuracy or completeness of this information.

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