Luigi Zingales’ COVID Zombie Attack

Too often, entrepreneurs and managers use the threat of massive layoffs to secure large, unwarranted subsidies. After the COVID-19 pandemic, workers should decide whether such assistance is warranted.

CHICAGO – As Western economies emerge from the COVID-19 crisis, banks and governments are facing a new problem: how to deal with the corporate living dead. But an innovative worker-centered system might offer a possible solution.

In the United States and the European Union, business bankruptcies have declined in the 15 months of the pandemic, despite the severe recession that accompanies it. This decline is the result of the governments of rich countries – in their understandable desire to mitigate the economic blow of the pandemic – extending every possible safety net for business. Often, however, they did so without even trying to separate those with good economic prospects from those who did not.

As a result, the business sector’s natural selection process weakened precisely when COVID-19 accelerated many pre-existing trends, increasing the share of businesses that should be considered zombies. But policymakers now need to address the broader economic impact of keeping businesses unviable.

Of course, governments cannot abruptly stop all subsidies to businesses. During the pandemic, many otherwise healthy businesses racked up a lot of debt. Suddenly subjecting everyone to rigid market discipline would lead to a huge number of unnecessary bankruptcies.

Moreover, the economic and financial impact of an immediate disruption of support would be politically suicidal for any elected government. The negative shock to GDP would have severe effects on both unemployment and public finances, and the losses that a wave of bankruptcies would impose on lenders would further weaken bank balance sheets. The almost certain outcome would be massive voter dissatisfaction, while securing the downfall of the government in the next election.

At the same time, policymakers cannot continue to help all zombie businesses. Such aid would have significant fiscal costs and hamper the productivity growth that Western governments desperately need to solve many of their fiscal and political problems. The changes produced by the pandemic call for new and innovative companies. But it will be difficult for such companies to enter the market and grow if we waste so many physical, human and financial resources on keeping zombie companies alive.

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Separating living businesses from dead businesses is not easy, even in normal times: that is what the art of banking is all about. And while distinguishing between healthy and unviable businesses is difficult for the private sector at the best of times, it is particularly difficult to do so now, when there is still a high degree of uncertainty about the post-world world. pandemic to come. But the private sector can at least aggressively use incentives to capture diffuse information. This is extremely difficult for a government agency, especially one that does not have the necessary accumulated expertise.

This is a new version of an old problem explored in particular by Friedrich Hayek. As Hayek has shown, the distribution of knowledge in society is diffuse and it is difficult for a government to bring it together impartially.

But there is a possible way to solve this difficulty. If you want to assess the quality of a student, there is no more revealing metric than asking classmates. Those who learn day in and day out with a peer can better appreciate their talent. Likewise, no one can better assess the quality of a business than their own employees. To eliminate zombie companies, governments should therefore start making any subsidy to a company conditional on the approval of a majority of its workers.

The problem is, unlike classmates, employees are made to lie. If the company went bankrupt, they would lose their jobs. Because supporting their business doesn’t cost them anything, most will likely overestimate its future prospects.

But this problem can be easily overcome with the right incentives. In such a system, if a majority of workers voted in favor of the immediate liquidation of the company, its employees would receive unemployment benefits for longer. If they voted to continue, the government would inject money to make the business viable. But if it were to fail later, workers’ unemployment coverage would be severely reduced – perhaps to zero.

Workers who do not see a future for their company would prefer a longer period of social protection. On the other hand, those who think that their company has a future would not jeopardize it by voting for its liquidation.

If properly calibrated, such a program would be able to separate zombies from otherwise healthy businesses overwhelmed by the effects of the pandemic. It would do so by making the cost of subsidies explicit: more support today means governments might have less fiscal capacity to help workers tomorrow.

Last but not least, this system would empower workers. Too often, entrepreneurs and managers use the threat of massive layoffs to secure large, unwarranted subsidies. This time around, workers should decide whether such assistance is warranted.


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