We are spending double the amount of time on our streaming platforms compared to last year, close to 45.4 billion minutes spent on Netflix alone in the first few weeks of March 2020. Movie titles such as: 28 Weeks Later (2007), Quarantine (2008), Carriers (2009), and I Am Legend (2007), have provided an escape from our quarantined hideouts. Unfortunately, such movies about a virus-infected planet and roaming zombies are a bit too real to be pure entertainment. Rest assured, COVID-19 is NOT a Hollywood make-believe. It is a very serious virus working its way around the planet, infecting at least 1.8 million people and resulting in over 100,000 deaths. The battle of this virus seems to have leapt off the pages of a Hollywood script into reality, but so too has the battle of the zombies.

These zombies are not the same as the ones found in movies or video games, these zombies were already amongst us, pre-COVID, and have been slowly increasing in number since the 1990s. The recent measures put in place by the federal government and the Bank of Canada to battle the economic fallout from COVID-19 will lead to a further rise of zombies, more specifically, an increase of zombie firms.

A zombie firm is any business who, over an extended period of time, is unable to pay its debt-servicing costs from its current profits. There are two definitions used to classify a firm as a zombie. The first definition categorizes a firm that is at least 10 years old with an interest coverage ratio of < 1 for three consecutive years. The second definition expands the criteria of the first by considering the firm’s expected future growth potential. The expected future growth potential is determined to be low if the ratio of a firm’s assets (at market value) over the replacement cost is below the median of that of the firm’s sector.

Pre-COVID, the Bank of Canada found zombie firms to have been on the rise in Canada since the 1990s, estimating that 10% to 25% of the population of Canadian companies could be classified as zombies. Furthermore, the Bank of Canada noted that Canada’s zombie firm infection rate is greater than in other countries.

The World Health Organization (WHO) declared COVID-19 a pandemic on March 11, 2020, based on the reports that the number of cases of COVID-19 outside China had increased 13-fold and that the number of affected countries had tripled over a two week period (118,000+ cases in 114 countries and 4,291 deaths). One month later the total number of cases globally had risen 1340% to more than 1.7 million cases and at least 103,257 deaths (2306.4%). In light of such staggering numbers, many countries declared states of emergency and ordered non-essential businesses to close.

In Canada, 103 cases of COVID-19 were reported by March 11. Now, one month later, infections have increased by 22,538% (23,318 cases) and 653 deaths. Given the rapid increase in infections, all provinces declared states of public health emergency by March 26, and ordered the closure of all non-essential businesses by April 1. The provincial orders to close non-essential businesses all indicate that such orders will be in place until the government deems the COVID-19 threat is over. This leads to the million-dollar, or more like billion-plus dollar question?

Some health experts estimate and mainstream media have reported that a COVID-19 vaccine could take up to two years to develop. Virologists believe that the pandemic will end either when a vaccine is developed or once the population attains herd immunity. Based on the federal and provincial governments’ modelling, three scenarios are predicting as to when the first wave may end. Each scenario depends on different infection rates and quarantine/testing measures. The first scenario is an infection rate of 1-10% of the population ending in summer-fall 2020. The second sees an infection rate of 70%-80% of the population, again ending summer-fall of 2020, and the third scenario predicts an infection rate 25%-50%, ending fall-winter of 2021. Based on the modelling, scenario one predicts the lowest infection rate and the earliest return of non-essential businesses. Scenario three would see a lower infection rate than scenario two but a later reopening of non-essential businesses.

The S&P/TSX is the benchmark Canadian Index that represents approximately 70% of the total market capitalization of the Toronto Stock Exchange. Over the past month, most investors have seen a significant drop in the S&P/TSX Composite Index. Between February 20 and March 23, the index tumbled from 17,944 to 11,228 (37.4% decline). However, due to recent government and Bank of Canada actions, the markets have rebounded about 26% to 14,166.63 on April 9, 2020. To put this into context, during the 2008 recession, the S&P/TSX Composite Index sunk by 35% and took two years to rebound 45%. The last two times the Index reached levels lower than 11,228 were back on July 3, 2010 (11,196) and May 19, 2012 (11,280).

The federal government’s economic response plan, slated to last until June 6, 2020, includes wage subsidies of 75% of an employee’s wages (up to $847 per week) for employers of all sizes and across all sectors who have suffered a drop in gross revenues of at least 15% in March, and 30% in April and May. On the monetary side, the Bank of Canada’s COVID-19 action plan has lowered interest rates, begun purchasing Government of Canada securities and Canada Mortgage Bonds (CMBs), all in an effort to improve market liquidity. Such economic measures by most opinions are well in-line with standard economic thought; however, such actions reduce financial pressure on firms and create very low interest rate environments. These conditions are perfect for causing a rise in zombie firms. Many studies show significant increases in zombie firms in the wake of financial crises and low interest rate environments that usually follow. With the best projection dealing with the first wave of COVID-19 being companies losing at least one entire fiscal quarter, and the worst scenario up to an entire fiscal year, it can be anticipated that zombie firm infection rates amongst the Canadian business population will dramatically rise.

High rates of zombie firms may not appear as immediately concerning as the onslaught of zombies in the movies or video games, but rest assured the economic impact that zombie firms have on an economy and its performance is real. Zombie firms have much lower labour and factor productivity, and crowd out potential growth and investment opportunities for productive firms. Not only do zombie firms waste resources, depress product prices, raise wage and funding costs for productive firms, zombie firms distort the debt markets and dilute economic measures meant to provide assistance to countries’ economies.

As the COVID-19 curve flattens and the end of the first wave draws closer, it will be important for governments to place their focus on the rise of zombie firms and concentrate on flattening that curve as well to ensure economic measures and resources for productive firms do not go to waste.

Gerard Lucyshyn is the Vice President of Research at the Frontier Centre for Public Policy

Like this: Like Loading...