NCPA - National Center for Policy Analysis


April 14, 2006

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, says the Economist. But protecting firms from the need to take radical action can have even worse long term consequences. Doubters need only look at the Japanese experience of 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 subsidized by badly regulated banks. Those "zombie" companies then damaged the profitability of healthy rivals, making entire industries sick.

According to the Economist:

  • 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 more generally, congesting the markets.

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. 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, America's airlines are adapting to reality too slowly, says The Economist.

Source: Editorial, "Don't Feed the Zombies," Economist, April 8, 2006.

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