Don't feed the zombies
Apr 6th 2006 | CHICAGO
From The Economist print edition
What Japan can teach America about coddling companies in debt
THE big complaint against many troubled American firms these days?from airlines to makers of car parts?is how they use bankruptcy to weasel out of pension promises and union contracts. But protecting firms from the need to take radical action can have even worse long-term consequences. Anyone who doubts it should look at the experience of Japan in the 1990s.
Japan's ?lost decade? followed a nasty collapse of property and share prices. But the subsequent debt and deflation did not have to drag on for so long. The problem was that Japan's weakest firms?especially in non-manufacturing industries isolated from global competition?were subsidised by badly regulated banks. Those ?zombie? companies then damaged the profitability of healthy rivals, making entire industries sick. The process is laid out in gruesome detail in a new study by three economists: Ricardo Caballero of the Massachusetts Institute of Technology, Takeo Hoshi of the University of California at San Diego and Anil Kashyap of the University of Chicago (?Zombie lending and depressed re-structuring in Japan?, NBER working paper, March 2006).
The trio define a zombie as any Japanese firm that got fresh bank loans at cheaper interest rates than the risks warranted?ie, subsidised credit. Banks were throwing good money after bad in this way because twisted regulations made it simpler to prop up weak borrowers than cut them off.
The results were perverse. First, the sectors with the most zombies ended up losing the fewest jobs during the late 1990s, in seeming defiance of market forces. Productivity in those sectors also fell more than it needed to, because unproductive firms kept operating and productive new ones failed to emerge. Even worse, healthy firms in zombie-infected industries did not invest and expand because the zombies lingered on?driving down prices, keeping workers in unproductive jobs and, say the authors, ?more generally, congesting the markets?.
American banks do not lend money in such distorted ways, but the country's flawed bankruptcy system can have similar effects. Indeed, the perverse effects of bankruptcy law have been a standard complaint of American airline executives for many years?except, of course, when their own firms are the ones being propped up by ?Chapter 11? bankruptcy protection.
But the system seems to be improving. In the 1980s, says Edward Morrison of Columbia law school, bankruptcy let entrenched managers at troubled firms avoid restructuring: for an example, he points to Eastern Airlines, which kept flying and wasting capital at cut-throat rates while in bankruptcy. However over the past ten or 15 years, he argues, creditors have become much more powerful, and can now push through real restructuring plans reasonably quickly.
Still, says Mr Kashyap, America's airlines are adapting to reality too slowly. He reckons that Southwest Airlines, a low-cost and highly profitable carrier, would have gained far more market share by now if the industry were not cluttered with zombies.
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