A successful industrial strategy requires letting zombie firms die

 
Phil Mullan
Performance Artists Hold Zombie G20 Protest
Stop sustaining the zombie economy (Source: Getty)

As the government considers its industrial strategy white paper, due later this year, it must first break free from blinkered thinking.

While doubtless well intentioned, the familiar policies under discussion so far – additional public infrastructure investment, more state-funded research, and skills enhancement, with a particular focus on management training – are not sufficient to bring about a new industrial revolution.

The flaw in this approach is that none are new practices – and even as they have been operating, Britain’s productivity trap has been getting worse.

Read more: Low interest rates and high public spending drag down productivity

Repeating what hasn’t been working is not a good route.

The output of the average worker each hour has not improved for almost a decade. The rot can’t be attributed to the impact of the financial crisis: the productivity growth rate has been in decline since the 1960s.

It is not credible that more of the same tried and tested policies are going to reverse this.

However much we need better transport services, cheaper housing, more basic research and improved training at work, none of these get to the crux of the problem.

Unless an industrial strategy can secure steadily rising prosperity for everyone, it is not worth much. To achieve this requires a range of sectors and industries – including completely new ones – producing goods and services at high and increasing levels of productivity.

History since the first industrial revolution tells us that the only way to raise productivity consistently (not occasional one-offs) is by big investments in the latest technologies, both by new and by existing businesses.

In its report last week, the Office for Budget Responsibility drew attention to just how “very weak” business investment has been since the financial crisis.

Business investment today is just five per cent above its pre-crisis peak almost a decade ago. In contrast, a decade after the early 1980s and 1990s recessions, investment was 63 and 30 per cent higher than the pre-recession peaks respectively.

Net business investment has been in decline since the 1960s. Reversing this trend is the only meaningful criterion for a successful industrial strategy.

A fascinating study of business productivity from the Enterprise Research Council in June 2016 points to what needs to be addressed. During the 15 years to 2013 for which the data is available (and probably from much earlier), we have had relatively fewer businesses with rising productivity and an expanding tail of low and declining productivity ones.

Contrary to the image that we are living in highly entrepreneurial times, the share of active startups has been in steady decline. The share of firms less than one year old among active businesses has nearly halved in the decade after 2004, from just below 30 per cent to about 16 per cent.

The study also shows that the proportion of genuinely growing companies has been contracting, from a little less than a half in 1998, to just over a third following the end of the financial crisis.

This explains the productivity puzzle: the proportion of businesses that have been growing revenues and productivity has been in decline, while the share of businesses with low and declining productivity – “zombie businesses” – has been expanding.

The zombies have been having a double adverse effect on productivity. The bigger tail of poor performers brings the “batting average” down, while its preponderance clogs up the economy and discourages the remaining stronger businesses from investing in growth.

The challenge for industrial policy is how to shake this up and reverse the trend, to bring about more investment in new higher-productivity businesses, industries and jobs, replacing poor productivity activity.

For several decades, government policies have increasingly been perpetuating this state of affairs, by keeping existing low and falling productivity firms alive.

We see this effect from policies over public spending , welfare, insolvency, and regulation.

The vast bulk of these policies tend to favour the status quo, to support existing businesses. This appears helpful in the short term but is at the cost of impeding the creation of the new.

Nowhere are these status quo policies clearer than in the monetary arena. Very low interest rates have been alleviating the burden on zombie firms of servicing their debts, allowing them to survive for longer than they normally could.

The starting point for an effective industrial strategy to revive productivity-enhancing investment is for governments to stop doing everything that has been sustaining the zombie economy, while financially sponsoring workers and families through the tough transitions to the better jobs that only such a big industrial shake-up would enable.

Phil Mullan will be speaking at the session Rebooting Britain: industrial strategy for the 21st century at the Battle of Ideas festival at London's Barbican Centre over the weekend 28-29 October.

Read more: How the UK can plug the productivity gap

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