Bill Jamieson: Will zombies be the death of us?

The “zombies” comprise thousands of Scottish companies that are effectively dead in the water – unable to repay their debts and clinging on by the skin of their blood-stained teeth as the economic storm continues to rage.

Looking at the raw numbers, it does indeed look as if corporate Scotland is fast becoming a zombie zone. According to the insolvency trade body R3, there are almost double the number of Scots and Northern Irish zombie companies compared with the rest of the UK.

Its research found 18 per cent (30,600) of Scottish and Northern Irish businesses who say they were only able to pay the interest on their debts but not repay the debt itself – which is the definition of a zombie business.

This was double the UK average of 9 per cent (160,000 businesses) and the highest figure for any area of the UK, with Greater London next at 17 per cent and the North East at 9 per cent.

Seven per cent of Scots and Northern Irish firms said they struggled to pay their debts on time and the same percentage said they were negotiating payment terms with their creditors.

R3 council member for Scotland, John Hall, comments: “This means that there are an estimated 30,600 zombie businesses which are only just staying afloat by paying the interest on their debt. Any change in circumstance could push many of these businesses into insolvency as they have no financial flexibility to cope with increased costs. Many of these businesses may continue to exist for several more years and be unable to invest in equipment or training for staff, which is likely to contribute to further economic stagnation.”

Now his is a highly controversial assessment. The label “zombie company” has provoked anger among companies bravely struggling on to survive. They continue to provide badly needed jobs even if, because of circumstances outwith their control, they are unable to grow their business. A prominent Scottish business consultant I spoke to last week said: “Considering that many struggling companies are helping the economy and employment, the term ‘zombie’ is a little mean.

“So-called zombie companies are not permanently dead – many will come back to life. But the banks need to distinguish between extending loans to help a failing company to survive and one that has a business plan where finance is needed for growth. This is the critical distinction to make. We need to keep this in proportion.”

Now there is much more to this issue than the use of an unpleasant and denigrating term. It goes to the heart of how best we can turn the business cycle and get the economy growing again.

The economist Joseph Schumpeter, in his classic study of the business cycle, advanced the theory of “creative destruction” – the means by which new entrepreneurs put the assets and finance capital of failed companies to more productive use by creating new businesses from the ashes of the old.

Indeed, the term “entrepreneur”, which he popularised, came from a French word meaning “undertaker”. By allowing failing businesses to go under, you release the resources necessary for new companies to take their place.

By this theory the banks stand accused of holding back recovery by “forbearance” – enabling failing businesses to cling on by not calling in loans.

The alternative thesis is that a mass rug-pulling by the banks would force the collapse of thousands of businesses and send the economy – already fragile – into a tailspin. Banks need to support zombie companies and the jobs they sustain so that they will be able to take advantage of a recovery in domestic demand.

However, there is a baleful prospect that more companies will fail in the course of the next two years. As John Hall points out, “Given that the Governor of the Bank of England, Sir Mervyn King, gloomily predicted that Britain, ‘may be in for a period of persistently low growth’ there is real concern that we may be about to experience large scale corporate failures.”

“We know that banks are displaying greater forbearance in relation to existing debt, but when a business cannot get extra lending it will be unable to expand. Others would argue that this stagnation ties up capital that could be used by other, healthier businesses.”

Corporate insolvency rates in Scotland are at a historically high level. Over the past four quarters 1,582 Scottish companies have gone bust – more than twice the number which went bust during the whole of 2009.

John Hall continues: “There is an argument that the benign interest rate regime and more flexible response from lenders have kept corporate failures artificially low.

“This is certainly the case in England and Wales but we can see that Scotland still has a very high rate of failures and an enormous number of zombie firms waiting in the wings for the slightest adverse change to close them down.”

Grim, or what? Zombie Scotland is a worrying assessment. But when it comes to applying the accountants’ definition of zombie, the entire debt-soaked UK government would amply qualify. Killing it off and starting again would be the logical conclusion.

Zombie? Beware the implications of a term that would condemn us all.

Twitter: @Bill_Jamieson