Will failing firms clear the path for thriving successors? Not in this recoveryby Megan Greene / November 11, 2020 / Leave a comment
The pandemic has wrought destruction. The question for economic recovery—and for investors—is whether it will be what economist Joseph Schumpeter called “creative destruction,” whereby new, more productive businesses spring up to replace those that failed. There are some tentative beginnings, but because of the nature of the crisis, the creative aspect may not be as powerful as in economic shocks of the past.
Schumpeter theorised that economies evolve as innovative companies are established that, over time, crowd out older, less productive ones. In this case, however, it wasn’t competition but the virus and the lockdowns it caused that killed off businesses on such a massive scale. It will be hard to replace them.
To be sure, opportunity and necessity have led to a flurry of new business creation. In the US, the Census Bureau reports that applications to start a new business are up nearly 20 per cent compared with last year. Company incorporations in the UK are also up. The growing number of people out of work have less to lose from trying to start a business. And easy monetary policy has kept borrowing costs at bargain levels.
But does this rise in business formation signal a gale of creative destruction? Not likely. Companies are not necessarily being built around creative ideas with long-term business models so much as from desperation. There was plenty of that when Schumpeter published his theory in the wake of the Depression, but also scope for spectacular productivity growth in the 1930s underpinned by factors that no longer apply—positive demographics, under-capitalised firms and more women joining the workforce.
Even as many companies failed this year, unprecedented stimulus by central banks and fiscal authorities kept others on life support. As a result, US bankruptcy filings actually fell 28 per cent in the first nine months of 2020 relative to a year earlier. UK company voluntary dissolution applications were down 20 per cent between early February and October. The policy intervention saved jobs and helped some viable firms survive, but it may also create “zombie companies,” which are not dead but staggering on. In Europe, which has relied more on wage guarantee and furlough schemes, workers may…