Businesses need pruning as well as feeding to make our economic garden grow

Stephen King
Alamy Stock Photo

There are almost three million businesses in the UK, ranging from the very big (Tesco, say) to the very small (your local handyman). Each year, around 13 per cent of these businesses are newly ­created. Another 12 per cent die.

The process is a variant on “survival of the fittest”. The failures create space in which businesses with prospects can flourish. That space is inevitably reduced if businesses that should be put out of their misery continue to stalk the world as the “living dead”, the financial equivalent of zombies. In that sense, business failures are a socially acceptable (if personally regrettable) fact of life.

Economists from all parts of the political spectrum recognise this process: whether they’re free marketeers or Marxists, they call this “creative destruction”, a term popularised by Joseph Schumpeter, the Austrian-born economist, in the Forties. When it doesn’t ­happen, the result is likely to be dis­appointingly weak economic growth. Japan’s so-called “lost decades” were partly a reflection of mass corporate “zombification”.

There’s a strong element of Darwinism in the process. And, as a very good friend reminded me over the weekend, the process also reflects standard horticultural techniques. In her view, the chances of getting a decent tomato crop are reduced dramatically if the gardener forgets to do plenty of pruning. The plants need to be “encouraged” to deliver maximum efficiency.

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Chin Chin Ice Cream

I’m no gardener, so I have no idea whether pruning is the best advice (indeed, a quick check on Google suggests that tomatoes are more likely to benefit from plenty of sunlight and a slightly acidic soil). I do know, however, that an absence of both business start-ups and failures is unhelpful for economic growth. And without failures, the room for start-ups is reduced.

Since the global financial crisis just over a decade ago, the number of business start-ups in the US has been persistently lower than it used to be. So has productivity growth, the secret sauce behind rising living standards. That’s no coincidence.

Massive monetary support in the aftermath of the financial crisis helped to ramp up asset prices. Large, inefficient companies were thus able to survive more easily, denying new start-ups the space in which to grow.

Japan’s so-called ‘lost decades’ were partly a reflection of mass corporate ‘zombification’

The Organisation for Economic Co-operation and Development has shown that in the aftermath of the global financial crisis and across a range of different industries, companies too slow to embrace new technologies nevertheless happily stayed in business when in earlier times they would have either disappeared or been taken over.

Without the entrepreneurial talents and risk-taking that come with new business creation, there’s less in the way of innovation and, ultimately, fewer jobs. It’s one reason why the central planning so beloved of the Soviet Union and its satellites ultimately failed.

Central planners tend to be bureaucrats, not entrepreneurs. And Soviet bureaucrats were typically motivated more by a fear of individual failure than a love of collective success.

The response to the Covid-19 crisis (and the associated economic lockdowns) has been to place a supportive arm around businesses. It’s an appropriate response. Yet cheap loans, government grants and furlough schemes allow both good companies and zombies to survive. The room for new companies to be created — the ones with the entrepreneurial spark, the risk-taking, and (potentially) the fast-growing employment opportunities — will be diminished.

In normal times, we let capital markets and banks decide which companies are deserving of financial support and which should be put out of their misery. We intuitively believe that Adam Smith’s “invisible hand” will do a planner’s work more effectively and is less likely to be prone to political interference.

Covid-19 has changed all this. In the middle of lockdown, the “invisible hand” cannot be trusted for the simple reason that it is blind to lockdown’s effects.

The hand cannot easily discriminate between “good” and “bad” companies because health protocols make too many good companies look bad. The hand cannot easily assess which companies will eventually thrive when, God willing, an effective vaccine changes all of our lives for the better. And the hand is certainly unable to work out whether prospective companies that, as yet, do not exist, are likely to do well in a world in which Covid-19 continues to haunt us.

The inevitable result is that we end up supporting the vast majority of our existing companies (the good, the bad and the ugly) at the expense of those that, today, may be no more than a twinkle in the entrepreneur’s eye.

The cost won’t be felt immediately. In a handful of years, however, we may be left wondering why living standards aren’t rising quite as quickly as we had hoped. The dynamism that we associate with market economies will struggle to make its presence felt.

All of this suggests that, when we eventually fully emerge from lockdowns, we’ll need to focus not just on the businesses that have struggled to cope through the crisis itself, but also on the conditions under which future businesses may come into being.

Back to my friend’s sunny garden. Imagine the local council issues an edict telling all gardeners that, thanks to an increase in greenhouse gases, no plant can be destroyed. Every plant is sacred. There is no legal difference between her tomatoes and, say, Japanese knotweed. It’s not difficult to work out the consequences. There’ll be no more tricolore salad and no prospect of home-made ketchup.

Stephen King (@kingeconomist) is HSBC’s Senior Economic Adviser and author of Grave New World (Yale)