This week the Financial Times reported that the UK Future Fund – a government-run venture fund set up during the pandemic – has mostly invested in “zombie” businesses that have no long-term viability. This is not surprising, given the apparent confusion over whether the fund was focused on growth or simply providing a backstop for high-risk businesses.
The minutes from an audit committee in June 2021 said the £1.1bn portfolio made up of 1,190 early-stage companies had “a significant tail of dormant companies”. This should annoy UK taxpayers that funded this scheme. But what should annoy taxpayers more is that this statement could also be applied to the whole UK economy.
For the last decade, barely profitable businesses have been propped up by ultra-low interest rates. In the 12 years after the Great Recession, there was a net increase of 2.3mn companies in the UK, according to data from Companies House. In the 12 years before, the net increase was 1.5mn. New company formation may sound like a good thing but if uncompetitive businesses aren’t dropping out, as new innovative ones form, the market becomes crowded and resources are wasted.
In the last two years, the government has joined the Bank of England in keeping unprofitable businesses afloat. The Treasury created the Coronavirus Bounce Back Loan Scheme (BBLS) in 2020 and handed cash out to almost any business that wanted it. According to Conservative think tank Onward, 1- 4 per cent of businesses became “zombified” last year.
The furlough scheme was vital in helping people employed in hospitality pay the bills, but it also meant taxpayers picked up the wage bill for companies that otherwise would have gone bankrupt. Ever wondered where all the potential airline employees are? Lots may well work for companies that will be bankrupt in the near future.
Creative destruction, a phrase coined by economist Joseph Schumpeter in 1942, is the process by which companies are constantly replaced by more efficient ones. This process is essential for an innovative economy and was put on ice during the pandemic. In the 15 months before the first lockdown, there were 21,287 company insolvencies in the UK. In the 15 months after, there were 14,146 – 34 per cent lower.
Aided by rising interest rates and energy costs, the creative destruction process is now working to make up for lost time. In the second quarter of the year, there were 5,629 registered company insolvencies, up 81 per cent from the same period last and the highest quarterly level since 1960. Begbies Traynor, the listed corporate restructuring firm, said that 200,000 businesses failed to meet the repayment terms for the BBLS in its recent Red Flag Alert report.
There is a belief that wishing for creative destruction is a privilege for those in the top 1 per cent. However, a higher rate of business replacement is correlated with increased social mobility. French economist Philippe Aghion found that more innovative firms paid higher wages to younger low-skilled workers, based on UK data collected between 2004 and 2015. California is the most innovative state in the US and has much higher rates of social mobility than Alabama, which is the least innovative state.
Reading headlines of rising liquidations might be adding to the general sense of news flow anxiety we are all feeling, but it shouldn’t. New and more productive businesses that pay higher salaries will take their place and that is good news for everyone in the country. Both rich and poor.
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