4 March 2021

Rise of the Zombies: how low rates and state intervention are dragging Europe down

By Nikola Kedhi

Once the continent of innovation, art, democracy and non-conformity, Europe has been laid low by a heady brew of bureaucracy, over-regulation, over-taxation and debt. A crisis of political leadership has in turn produced a deficiency of bold, innovative ideas, a shortage of vision and a huge expansion of government intervention. Nowhere is this clearer than in the EU’s ill-fated monetary misadventures.

Throughout the last decade, the European Central Bank has pursued a program of Quantitative Easing program that has pushed interest rates into negative territory, all in the name of keeping the EU together. Unlike the US Federal Reserve, however, the ECB has still not unwound its QE program. Meanwhile, national governments continued with failing Keynesian policies instead of desperately needed supply-side reforms. Naturally, this has had negative consequences that far outweigh any benefits that the QE plan might have produced.

One of the costs of endless QE is the growth, at a disturbing pace, of so-called zombie companies. The Bank for International Settlement’s defines a zombie as “any firm which is at least 10 years old, publicly traded and has interest expenses that exceed the company’s earnings before interest and taxes”.

Though this phenomenon is certainly not confined to the EU, it is proving to be deadlier on the old continent when combined with harmful government interventionism that channels capital away from productive companies towards the zombies. 

These companies are in a kind of limbo – neither productive, nor seeking to enter formal insolvency proceedings. The zombies are plagued by large amounts of debt, low levels of profitability, negative margins and no capital for growth, meaning they effectively produce nothing. They survive because they get some sort of cash, often from the government, which enables them to pay the interest on their debt. Creditors allow them to continue existing for as long as they continue to pay interest. 

The economic consequences appear to be considerable. A 2017 OECD report showed that in Belgium, for example, reducing the zombie shares to the lowest levels would result in a 1.7% gain in investment for a non-zombie company. In Italy, the same report shows that between 2008 and 2013, at the height of the previous crisis, non-residential private investment declined by over 20%. The report concludes that “a simple back-of envelope calculation suggests that zombie firms could account for perhaps one-quarter of the actual decline in private non-residential business investment”. According to the Bank of International Settlements “estimates indicate that when the zombie share in an economy increases by 1%, productivity growth declines by around 0.3 percentage points”.

Therefore, as a 2019 European Commission report concludes, they get a huge amount of capital that is used unproductively, crowd out healthy companies, lead to a fall in investment and innovation and dampen the prospects for future growth. The lower interest rates are, the higher the misallocation of capital by governments, the more these companies will expand, until they asphyxiate the economy, fully zombifying it. But interest rates will not remain this low forever – when they start rising, that is when the consequences will be felt.

It is understandable that during recessions the share of this type of firms increases. However, it is unacceptable that the percentage of zombie companies is higher now compared to the peak of the financial crisis in 2008 and the debt crisis in 2012. The progress of the trend is also deeply concerning: an analysis by Natixis, a French bank, puts the share of zombies at 21% in 2019, up from 11% in 2008 and 3.5% in the 1990s. 

Negative rates and irresponsible fiscal policies have created the perfect terrain for zombie companies to thrive to the detriment of the economy, by getting cheap debt, without any value added. 

According to an analysis made by KPMG in 2019, the sectors in the EU that have higher numbers of zombie companies are the ones in which government intervention is higher, such as healthcare and energy, with approximately 25% and 24% of all companies listed on Euronext.

Governments with their stimulus packages, not only increase debt to frightening and unsustainable levels, but also channel some of the capital towards these companies. 

To make matters worse, the Covid crisis has created another pretext for billions of euros to be spent on zombies. Historical data show that with every stimulus package, companies that have connections to the government are the first to be bailed out – the antithesis of a free market.

Despite all this, nobody in Europe seems the least concerned about repeating the failed policies of the past, increasing debt and lowering productivity. While the US cut taxes, deregulated and incentivised companies to expand and invest, the EU continued to regulate, increase taxation and expand its bureaucracy.

If it continues like this, Europe’s future is certain: a geopolitical irrelevance with a zombified economy.

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Nikola Kedhi is a financial consultant and a contributor to Il Giornale, The Federalist, and Nazione Futura.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.