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zombie companies

Zombieland

At the heart of Capitalism lies Creative Destruction


Joseph A. Schumpeter

One of the most important risks in the face of the Covid-19 pandemic is the emergence of an increasing number of zombie companies in Mexico and the world. The term zombie company was first used in Japan in the 1990s, after the economic and stock market collapse of the late 1980s. With that term they referred to those companies that were still financed by Japanese banks despite not having the possibility of paying the financing that they were still obtaining. A zombie company is a business that generates enough cash to continue covering its fixed and operating costs and to cover the payment of interest on its debt, but which will never generate sufficient resources to cover capital payments. Therefore, it can remain in a state of artificial life as long as its creditors allow.

Since the global crisis of 2008 we have entered an era where the world’s major central banks, through their aggressive low interest rate policies, have created major distortions in the economy. An environment of monetary easing such as the one we are currently experiencing – the second most important in less than twenty years – helps the economy, is good for preserving jobs, but also produces the enormous risk of artificially keeping companies alive that should go bankrupt, while creating asset bubbles in various sectors of the economy.

The problem with zombie companies is that they detract dynamism from the market, subsidizing and hiding inefficiencies within organizations, taking away financial resources from other companies and projects where the use of capital would be much better, and generally producing economic distortions that eventually will have a cost to society. One of the main strengths of capitalism is what the famous Austrian economist Joseph Schumpeter identified as the “force of creative destruction“. Creative destruction allows companies that are not strong enough to go bankrupt, freeing up valuable economic resources that can be applied to better projects, and allowing efficient distribution of capital in the long run. Creative destruction favors innovation, technological development and continuous improvement, which makes organizations also more efficient to compete in their national and international markets.

The current environment is creating an extremely complicated dilemma for the world: On the one hand, it is necessary to provide support to certain companies and certain industries that would be too costly to lose. On the other hand, there is a risk of generating long-term distortions that will also be very difficult and costly to correct later on. Recessions and crises have the positive effect of eliminating excesses and inefficiencies from the markets, and therefore it is important to let these processes work properly and at the right time. Otherwise, in a few months or years we will be talking about how to rescue the financial sector, who will eventually have to deal with the credit quality problems caused by these zombie companies, which were allowed to live too long on artificial form. I believe that no country is finding the right equilibrium to balance short-term support with long-term economic distortions, and this may very well be the seed of an even bigger crisis.

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