Growth or bust
If there were more corporate collapses, the economy would be a healthier place
Given the collapse of Comet last week, here’s a contrarian claim: far too many companies are staying solvent, avoiding bankruptcy and continuing to trade despite the troubled economy. If only we had a few more corporate collapses, the economy would be a healthier place.
Could this possibly be true? It’s not quite as mad as it might seem. An economy with a vibrant entrepreneurial culture, in which new companies with good ideas find it easy to raise money and reach customers, is also likely to be an economy in which slow-footed incumbents find themselves outcompeted and out of business.
To look at the same problem from a different angle, think about an economy in which banks prop up loss-making companies because of political pressure, or because foreclosure would crystallise a loss at an awkward moment for the bank, while forbearance would postpone the day of reckoning for both borrower and bank.
If such forbearance allows a fundamentally profitable company to survive temporary cash flow problems, it will be good for the economy, of course. But a persistently lossmaking company is a machine for converting equipment, business premises and the hard work of its employees into something worth less than the sum of its parts.
Jon Moulton, a corporate turnaround specialist and chairman of Better Capital, a private equity group, has been arguing that this is an accurate and worrying depiction of the economic scene today. Moulton points to the fact that in the UK, business liquidation rates averaged about 160 per 10,000 companies in the 1990s, but didn’t reach 100 even during the depths of the crisis. And Moulton told BBC Radio 4’s The Bottom Line that across Europe, countries such as Greece and Italy enjoy low bankruptcy rates while those in Germany and Norway are much higher.
That last factlet seemed so astonishing that I felt compelled to check. Moulton is quite correct. According to a report compiled by the Creditreform Economic Research Unit, Greece suffered only five insolvencies per 10,000 companies in 2011, the lowest ratio in western Europe. The three runners-up were Spain, Italy and Portugal. Germany and Norway both had bankruptcy rates well above the European average of 68 insolvencies per 10,000.
This is not conclusive. The differences will, in part, be determined by countries dealing with insolvencies in different ways and to different timescales. (Iceland’s rising bankruptcy rate is more likely to be a delayed reaction to the crisis of 2007 than a sign that things have never been worse in Reykjavik.) Different insolvency rates will also reflect the maturity of the economy: many Greek businesses were self-employed professionals, people who might simply stop trading rather than enter any formal bankruptcy procedure.
Still, the idea that corporate failure reflects economic vitality makes a good deal of sense. In a study published in the Journal of Financial Economics in 2008, Kathy Fogel, Randall Morck and Bernard Yeung compiled lists of the 10 largest employers in each of 44 countries across the world. Fogel and her colleagues found that when the membership of this elite group of companies changed frequently, the economy in question was more likely to be growing quickly.
Perhaps more impressive is the fact that churn in the top 10 list in a given year was correlated with fast growth over the subsequent decade. Even more striking, the results were being driven by the extinction of corporate dinosaurs rather than the rapid ascent of new stars. The ability to fail quickly – and without much collateral damage – is a tremendous economic asset. Just think of the companies we now think of as too big to fail.
Also published at ft.com.