For many years before it ultimately collapsed, the Hudson's Bay was among the growing ranks of Canada’s 'zombie firms.'Nathan Denette/The Canadian Press
Tom Goldsmith is the founder and principal of Orbit Policy and author of the newsletter Orbit Policy’s Deep Dives. Previously, he was the director of innovation policy for Mitacs and the Toronto Region Board of Trade’s policy director for innovation and technology.
The final collapse of the bankrupt Hudson’s Bay Co. unfolded much like Ernest Hemingway described bankruptcy nearly a hundred years ago, “Gradually and then suddenly.”
While the suddenness of the Bay’s fall may catch the eye, it is not its exit but its gradual decline that should serve as a warning for us. For many years, the Bay was among the growing ranks of Canada’s “zombie firms.” These companies are poorly performing businesses that never exit and that continue to suck up talented staff and government subsidies. They struggle to make interest payments and often have poor expectations of future profitability.
Troubled retailers such as the Bay, Linen Chest and Toys “R” Us may be the most recognizable zombie firms. But they exist far beyond Main Street, infecting every sector. Most concerningly, these zombies are a major drag on our economy.
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Research from Statistics Canada has found that around 5 per cent of all Canadian businesses are zombies. Even more concerningly, this rises to between 18 and 36 per cent among our publicly traded companies, with more than 50 per cent of publicly traded mining, quarrying and oil-and-gas extraction companies zombies.
Their productivity is only 55 to 60 per cent of that of healthy firms in Canada. More worrying, they are a growing part of our economy, with their capital and labour share consistently increasing from 2002 to 2019.
The persistence of zombie firms reflects a broader decline in business dynamism and creative destruction in Canada and other advanced economies. The causes behind this vary, from the structure of economies and the rise of intangible and digital intensity to regulatory burdens and red tape. However, another driving force is that we are preserving firms that would have otherwise died, helping create zombies.
Tariffs to protect domestic producers from foreign competition can do this, as can high levels of corporate concentration and a lack of competition. The need for government to step in to prevent major economic collapses during downturns also saves companies that otherwise could, and perhaps should, have died off. Subsidies for businesses also help maintain the status quo.
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One notable government subsidy, the federal scientific research and experimental development (SR&ED) tax credit, has long been observed to keep zombie firms alive, undermining its stated role in increasing our innovation. Furthermore, a cottage industry of consultants and lenders has spawned around that flawed program. It leeches off up to 30 per cent for themselves.
By sucking up so much capital and talent, zombie firms drag down the productivity, capital and payroll growth of healthy businesses. Because of this, Statscan estimated that these zombies had lowered aggregate productivity in Canada upward of 5 per cent in 2019.
Instead of the usual cry to support businesses through the latest economic challenges through measures such as interest-rate reductions and new financing, we should allow more companies to fail. Indeed, Nobel Laureate Daron Acemoglu and other leading economists have found that actively encouraging the exit of low-performing businesses by taxing all companies’ operations would yield substantial benefits to growth and welfare. This is because zombie firms exiting frees skilled workers to move to more productive companies.
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Meanwhile, industrial policies, such as SR&ED, were found to either be ineffective or reduce growth and welfare. Fortunately, zombies exiting en masse would not cause broader issues. A 2020 Bank of Canada analysis found that even if all zombie firms defaulted on their debt, it would not threaten the financial system.
Of course, allowing our zombie firms to fail would have real human impacts on their workers. Genuine reform of employment insurance is needed here. Only around 40 per cent of unemployed Canadians receive EI benefits, down from more than 80 per cent in the 1990s, and experts have complained that the program is too complex and has too many coverage gaps.
Resources should be put toward protecting workers instead of keeping zombie firms on life support through wasteful corporate subsidies. International evidence points to the advantages of this. Researchers have found that enhancing unemployment benefits allows more time for job searches, meaning workers find the best match for their education, talent and experience.
We need to think differently if we want to solve our productivity challenges and revive our economy. Perhaps the change we need is to allow more zombie firms such as the Bay to fail while ensuring their former workers are protected and set up to succeed.