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Upside of Inequality Oxford Unintended Consequences

Joseph Gagnon Peterson Institute for International Economics
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Concerns about zombie firms are overstated due to the limited opportunity cost of funding them, especially when the economy operates below potential.

Concerns about zombie firms are overstated due to the limited opportunity cost of funding them, especially when the economy operates below potential. With interest rates near zero, the cost to creditors of keeping loss-making firms afloat is minimal, allowing for potential recovery without significant crowding out of capital. Eliminating zombie firms can lead to an immediate GDP drop exceeding 100% of their production, as the loss in worker income reduces spending across the economy. This Keynesian multiplier effect underscores the potential harm of prematurely shutting down such firms. Moreover, the capital invested in these firms is often irretrievable, and the management teams are unlikely to transition to new industries, suggesting that maintaining these firms may be less detrimental than perceived.

Joseph Gagnon, "Who's afraid of zombie firms?," Peterson Institute For International Economics, October 22, 2020, https://www.piie.com/blogs/realtime-economic-issues-watch/whos-afraid-zombie-firms

Gagnon on why concerns about "Zombie Firms" are overrated in this current environment (economy operating below potential)"...When the economy is operating below potential and the forces returning it toward potential are absent or weak, the costs of killing zombie firms are huge. Killing a zombie immediately wipes out the income its workers have to spend on goods and services throughout the economy. This decline in spending drags GDP down by potentially more than 100 percent of what the zombie firm used to produce via a Keynesian multiplier effect..."

Ed Comment, “…You can add this for my comments but I’m not so persuaded by the zombie arguments. First, I think, far more often than not, things exist for good reasons. It’s the criticism that’s misguided. Second, why not stay alive if interest rates are near zero? Third, and interest rates are near zero because we don’t have good uses for additional capital so I don’t see much crowding out. Fourth, I don’t see much crowing out regardless because the capital is already in the ground so there is no way to retrieve it and use it elsewhere. Fifth, if there is an opportunity cost it’s with the management team keeping the zombie alive. But they are probably 55 years olds who aren’t going to transition to a new industry/company/job. What I see a lots of previously employed but now underutilized 50 year olds, not a shortage. I don’t think young talent is coming behind them to take their places. Is it so bad that we kept the pickup truck business alive in America with tariffs as long as our upcoming talent is going to places like apple and not GM? It was probably a good thing….”

"..Thus, killing a zombie firm when the economy is operating well below potential causes an immediate drop in GDP on the order of 100 percent (or more) of the zombie’s production, which is only gradually offset by eventual improvements in productivity amounting to a small fraction of the lost GDP. When the economy is operating below potential, many firms operate at a loss. In such an environment, central banks set interest rates close to zero,and it costs creditors little to keep loss-making firms in operation in hopes of renewed profitability when the economy recovers. There is nothing wrong with this outcome...."

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