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In the UK there is something confusing going on. They call it the productivity puzzle. Why is it that during the worst downturn ever suffered by the UK – at least it’s the worst since the beginning of the last century which is how far back the data goes – employment has kept growing to the extent that this year it passed an all-time high? Data provides a hard answer: productivity has been falling. But what the data does not do is provide the reason why.

Maybe the reason can be provided by the existence of Zombie companies. Once again, hard data comes to our aid – they really do appear to exist.

So interest rates were slashed to record lows, and then just to be sure they were slashed some more. That was the story of the great downturn: record low rates. If things had been different, if central banks have been more circumspect, had fretted about inflation, and moral hazard, then the great recession of 2008/09, and the downturn that began in 2008 would have been far far worse.

Company liquidations and indeed individual insolvency levels would have soared. House prices might have crashed. Unemployment would have risen to horrendous levels, and youth unemployment would have topped 50 per cent in some regions. In fact if the Bank of England and the Fed had adopted that policy, the UK and the US would have ended up looking a lot like the Eurozone.

Fortunately, in the democratic countries of the UK and the US the electorate would have never have tolerated such a state of affairs. It appears that the electorate in certain Eurozone countries was powerless to act; their cross on the electoral ballot had as much meaning as an Egyptian voting for the Muslim Brotherhood.

But just because record low rates stopped the UK from suffering an even worse downturn, it does not mean that the policy hasn’t come with disadvantages.

A year or so ago, the then FSA issued data showing that between 5 and 8 per cent of mortgages could be subject to forbearance. At that time, Dr Angus Armstrong at the National Institute of Economic and Social Research said: “This has a familiar ring of the zombie firms in Japan which were insolvent but the banks would not close to avoid crystallising a loss.”

But what about the corporate world? We keep hearing about zombie companies, but are they for real?

So here is the data:

First off here is the chart that shows something is wrong:

And now here is the chart that shows why zombie companies may provide a partial explanation.

The Bank of England put it this way: “Liquidations have risen only modestly since the financial crisis, even though data from companies’ accounts suggest that the proportion of companies making a loss is higher than in the early 1990s. Insolvency professionals suggest that more businesses have been able to survive the 2008/09 recession because of the low level of Bank Rate, coupled with increased forbearance. That includes forbearance by banks on existing loans, by HMRC on outstanding tax payments, and by other companies on late payments.

Forbearance and low interest rates will allow some viable businesses to remain in operation through a temporary period of weak demand. But in other cases, where businesses will find it hard to compete in their markets when demand recovers, forbearance acts as an impediment to the efficient reallocation of capital and labour, reducing underlying productivity growth. Similarly, it may have dampened the incentives to carry out the restructuring needed by some companies in order to grow strongly.”

But in the US, where the central bank has been just as proactive as the Bank of England in promoting low interest rates, things have been different.

As far as households are concerned, there is a key difference in the way in which the mortgage market operates. In the UK if you find yourself with negative equity, having your home repossessed does not help because it is still your responsibility to pay the shortfall. In the US, it is the bank’s responsibility. This has led to a more ruthless approach to mortgage repossessions in the US, but at least this is kinder on those with negative equity and who cannot meet commitments, and it is has led to fewer so-called zombie households.

As for companies and entrepreneurs, in the US the same stigma does not apply to bankruptcy as there is in the UK. Indeed for US entrepreneurs, it sometimes feels as if facing bankruptcy is a sort of rite of passage. Chapter 11 is often applied very effectively in the US – consider GM for example.

In the US, we have seen record low interest rates, but creative destruction too.

In the UK where –to a large extent – we have only had record low rates, it may become a problem as the economy recovers, and rates finally rise.

© Investment & Business News 2013

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