Cutting the Share of Zombie Firms May Lead to Productivity Gains

Says Miguel Sanchez-Martinez, an Economic Analyst at the European Commission

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An interview with Miguel Sanchez-Martinez, an Economic Analyst at the European Commission

Miguel Sanchez-Martinez is an economic analyst at the European Commission, based in Brussels. He specialises in macroeconomics and is a member of the Joint Research Centre, the Commission’s science and knowledge service. He spent three years working in London at the National Institute of Economic and Social Research (NIESR) before joining the research team at the European Commission in 2016. Below, he gives his personal thoughts on cutting bureaucracy and changing the way productivity is measured.*

Productivity growth has become a pressing concern among economists across Europe in recent months as nations try to contain the impact of Covid-19. Productivity growth has very profound implications, as it is considered to be the single most important determinant of economic welfare and standards of living in the long-term. Previous economic crises have shown that businesses tend to scale back on investment and conserve cash in times of uncertainty. So how can business owners and managers boost productivity at a time when they are likely to be mindful of costs? In this special report on productivity, spend management platform Soldo speaks with leading European economists and business specialists to find the solution.

Productivity stagnation is one of the leading discussion points in advanced economies today, says Miguel Sanchez-Martinez. Productivity growth forms the basis of per capita GDP growth, and is a “key element to maintaining high standards of living in the long-run” (European Commission, 2020). It is therefore critical that the factors behind the current productivity slowdown are understood and challenged if this major issue is to be tackled.

The Commission has undertaken an in-depth study into productivity growth across the EU, with policy-relevant results published in early 2020 following a one-year collaborative research project.

While many important messages are distilled in the report, one of the main conclusions is that innovation, digitalisation and investment in intangible assets are crucial aspects behind productivity growth.

Currently many countries in Europe lag behind the US when it comes to investment in research and development (R&D), both private and public, relative to GDP, which may partly explain why productivity growth in the continent tends to trail behind that in the US. GDP per hour worked in the EU is only around 70 per cent the US level.

The Covid-19 crisis, by its very nature, cannot be compared to the majority of past recessions, such as the financial crisis

Cutting bureaucracy 

Sanchez-Martinez says the older European member states that form the EU15, which includes France, Germany, the Netherlands, Spain and the UK, are more affected by the productivity slowdown than newer countries coming into the bloc. This is because the EU15 countries are becoming increasingly reliant on services, a sector that suffers from low productivity growth partly because of inherent characteristics to this sector (e.g., the untradeable nature of some services or the impossibility to automate them).

The Commission’s report says: “Recent evidence points to both the deterioration in investment in physical and ICT capital and a lower contribution from the latter as major contributing factors to subdued productivity growth in services.”

The report added there is evidence that regulatory barriers might act as an important hurdle to firm entry, thereby discouraging competition. However, this is highly dependent on the type of regulation. From a macroeconomic perspective, a high churn rate can be good for productivity growth as struggling firms exit the market and leave the successful ones to thrive.

“We call this the cleansing effect, which is what happened in the great recession of 2009,” says Sanchez-Martinez. “The weaker companies closed down while the stronger companies managed to survive and grow. But the current Covid-19 crisis is trickier to analyse and cannot be compared to other recessions in the same way because it’s very hard to tell whether companies are simply suffering from a short-term cashflow shortage due to social distancing measures, or whether they are “zombie” companies that were already struggling even before the pandemic hit. The major issue is how to identify firms that should exit the market and those who need support.”

Stepping up investment in certain types of intangible assets could be a way to foster productivity.


Measurement problems

Part of the reason for slow productivity growth across Europe is simply in the way it’s measured, Sanchez-Martinez says. Digital disruption has helped speed up many processes and reduced pace with technological advancements. For example, smartphones are continually being developed through software upgrades even after we have purchased them, but these updates are not included in any form of official GDP or productivity measurement.

He adds: “If we imputed all these quality improvements in price indexes, then the productivity stagnation issue would be lessened. That said, there is growing consensus that mismeasurement cannot, in and by itself, explain the entire observed productivity growth slowdown”.

Measurement issues are particularly acute in the services sector, which by its nature is not conducive to productivity growth.

Sanchez-Martinez adds: “There are inherent characteristics of certain service sectors which by their very nature prevent productivity from expanding. The most salient is their non-tradeable nature of most of them (for example real estate services and certain leisure activities). This acts as a barrier to external competition and expansion. There is however room for improvement in this respect due to advancements in IT, for example e-commerce giving companies a wider platform. However, it is important to bear in mind that certain sub-sectors within services – for example financial services and ICT – do exhibit productivity growth rates that are comparable, if not higher, than traditionally better productivity performing sectors such as manufacturing.”

Sanchez-Martinez adds that “when considering the impact of ICT on productivity growth, the relative sluggishness in ICT diffusion in continental Europe compared to the US could have been partly driven by the slow pace of growth in ICT-related skills. Our analysis also points out that intangible assets such as organisational capital, design, brand and training are a major contributor to labour productivity growth in the service sector. Hence, investing in these types of assets and improving ICT skills among managers might be important ways to boost productivity growth.”

Sanchez-Martinez’s key takeaways:

  • Intangible assets seem to be important for fostering productivity growth. Among these types of assets, organisational capital, brand, design, and training seem to carry more weight in driving productivity growth.
  • Regulatory barriers might play a role in explaining productivity stagnation in the services sector.
  • Part of the explanation for stagnant productivity growth is the way it is measured, as price indexes do not currently capture quality improvements, especially in certain sectors. However, efforts to improve these measurements are currently being undertaken by statistical institutes.

*All information and quotes given above are Sanchez-Martinez’s informed opinion and do not reflect the official views of the European Commission.

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