Zombie companies in Asia
July 2017 | FEATURE | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
July 2017 Issue
Since the financial crisis there has been an undercurrent of weak productivity growth affecting economies across the globe. One of the causes of this lethargy, in both developed and emerging economies, has been the spread of so-called ‘zombie’ companies. These organisations continue to operate despite being insolvent or near bankruptcy, stifling productivity, innovation and economic growth.
By continuing to attract funding, thanks to historically low interest rates and the leniency of creditors, zombie companies are depriving more economically viable companies of much needed resources. According to a recent Organisation for Economic Co-operation and Development (OECD) report, “a 3.5 percent rise in the share of zombie firms – roughly equivalent to that observed between 2005 and 2013 on average across the nine OECD countries in the sample – is associated with a 1.2 percent decline in the level of labour productivity across industries.”
Zombie organisations have been particularly problematic in Asia, with major economies in the region including Japan, South Korea and China affected to varying degrees. From state owned enterprises (SOEs) in China, to troubled shipping companies in South Korea, they are negatively impacting growth and productivity. The outbreak of zombies can be attributed to the actions of governments which refuse to allow ailing companies to die. By rolling out cheap financing solutions and offering support to failing firms, governments are playing a risky game. While the spread of bad loans and increased unemployment are undesirable, particularly in emerging economies, propping up failing companies can have a destructive impact on a national economy in the long run.
That these companies have continued to win financial support is unsurprising, given the state of many national economies and the period of slow growth which has defined the post-financial crisis era. Jurisdictions are searching for an effective stimulus package to help restore their economies to former glories. Arguably, the availability of stimulus schemes for zombies has done more harm than good
In China, zombie companies in the steel, coal and cement sectors have bloated already well populated industries, diverting resources away from more productive competitors.
In South Korea, the shipping industry has endured a difficult period with a rash of bankruptcies. On 23 March, the Korea Development Bank and Export-Import Bank of Korea, both state-run banks, agreed to lend the Daewoo Shipbuilding & Marine Engineering Co. Ltd $2.6bn and swap debt for equity to prevent a likely default. In a statement, KDB warned that if Daewoo were to go bankrupt, “the loss to the country’s economy could be vast as the whole shipbuilding industry could collapse and financial institutions could face further losses”. Less than two years ago, Daewoo Shipbuilding received an initial bailout of fresh loans and a debt-for-equity swap. While it is a difficult decision to make in the short term to lay off employees, failing organisations should arguably be allowed to fail. By monopolising investment, zombie companies are erecting barriers which will prohibit new firms from entering markets.
South Korea’s zombie problem extends beyond the shipping industry, however. In 2015, the country recorded more than 3278 zombie companies, a 17 percent jump from 2012, according to the Bank of Korea and Financial Supervisory Service. At the same time, Korean GDP growth has faltered, dropping to around 2.7 percent annually.
What lessons can be learned from Western economies? Recent economic history is littered with examples of economies which have continued to feed their zombie companies, preventing capital from being recycled and market share to be distributed among healthy, profitable businesses, thus fuelling economic growth. For the sake of protecting jobs in the present, China, South Korea and a number of other Asian markets, like many others before them, may be sacrificing the future.
Authorities in China have repeatedly vowed to intervene and kill off zombie companies operating in sectors with excess factories and large debts. They have begun to make some progress. Chinese courts accepted 5665 bankruptcy cases in 2016, an increase of 54 percent from 2015, due in part to a cull of zombie companies. Still, China’s state-owned asset regulator compiled a list of central government-owned zombie enterprises in 2016, identifying 2041 companies with total assets worth Rmb3.1 trillion. The government has called on regional courts to take on more bankruptcy cases.
China has targeted growth of 6.5 percent in 2017, and eliminating zombies should help the economy reach this target. Chinese courts will be pivotal to this process. Bankruptcy and liquidation divisions have been established at 73 courts throughout the country, and while the government would prefer distressed companies to be restructured, bankruptcy is now an option.
In the 1940s, Joseph Schumpeter, an Austrian-American economist popularised the Marxist theory of “creative destruction”, which suggests that the old must make way for the new if companies are to seize the opportunities presented to them. For economies in Asia, this is a lesson which must be learnt quickly.
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