Zombie firms gnawing on Canadian productivity

Studies suggest that Canada may have a bit of a zombie problem; not the brain or flesh-eating type, but zombified businesses that gnaw on national productivity, suppress wages and constrain the growth of healthy firms.

The term “zombie firm” was first coined to describe underperforming businesses during the post-bubble economy of Japan in the 1990s, when economically underproductive “zombie” firms were kept alive by government and bank loans. Zombie firms can be defined as businesses that perform poorly over a long period of time without folding.

While some have claimed that Canada leads the world in the prevalence of zombie firms, a new study suggests that from 5% to 7% of Canadian businesses overall fit the description, with publicly traded firms most likely to be zombified (18% to 36%).

This placed Canada in the middle of the pack globally in 2013, well behind Greece (16%) and Spain (10%) but higher than other advanced economies such as Italy (6%), Great Britain (4%) and France (2%).

While zombie firms are found in all industries in Canada, they were most prevalent in the mining, oil, and gas (11%) sector in 2019, especially among publicly traded companies, where up to half were zombified. Both these shares have risen substantially over time, roughly doubling since 2002.

This suggest the industry composition of zombie firms is becoming more concentrated into the highly volatile commodity sector, where large price fluctuations are common. Given the large, fixed investments in this sector, it may be optimal for these firms to continue operating as zombies in anticipation of higher prices.

Zombification is a highly persistent process, with over two-thirds (69%) of zombie firms retaining this status from year to year. It is relatively rare to exit and re-enter zombie status; this suggests that firms can become trapped in a perpetual state where they neither fold nor recover back to health.

While the share of zombie firms in Canada has fallen since 2011, their performance relative to healthy firms has been declining, and the resources that they are consuming have been rising. The study shows that the increasing presence of zombies in an industry negatively impacts the productivity and growth of healthy firms. Labour hoarding by zombies is particularly burdensome on healthy firms, indicating that zombies could exacerbate labour shortages.

Given the current labour shortages in Canada as it recovers from the pandemic, zombie firms could be undermining the ability of healthy firms to recover. The study shows that an increase in the industry capital (payroll) share of zombies decreased labour productivity, total factor productivity, capital growth and payroll growth of healthy firms.

In addition to lowering the productivity of other firms, zombies themselves have been performing worse. The study found that performance and productivity of zombie firms relative to healthy firms has declined considerably, with relative productivity declining by roughly 10% since 2002.

When compared with other countries, the productivity gap between zombie and healthy firms in Canada appears to be greater, suggesting that Canadian zombie firms were particularly unhealthy.

Since these zombies were also hoarding resources, they were increasingly lowering aggregate productivity by up to 5% in Canada in 2019. This is a substantial productivity loss that is driven by these firms not exiting the economy.

The full report, “Zombie firms in Canada,” is now available as part of the Economic and Social Reports series.