An undead economic cycle and its zombie firms: How state protection brings zombie firms and a bullish market together

Years ago, Halloween wasn’t a tradition in our small village, but my kids were eager to take part. I reached out to a small group of families from the local kindergarten, some of whom had Anglo Saxon roots. Ironically, it was me (a Swiss), who reintroduced Halloween, and we decided to meet with our children dressed as zombies in the local town. It was great fun — so much so that by the following year, what started as a small WhatApp group had ballooned from a manageable size to a troupe of 70 zombies walking the streets.

‍

But as the group grew, the energy changed. I noticed that people started behaving very differently now that they were part of a crowd. The group became difficult to manage and I became uncomfortably aware that we were asking for something (in this case, sweets), without giving anything back. This shift reminded me of what happens in an economy when corporate zombies are propped up by government support.

‍

The zombification of firms

‍

According to the Bank of International Settlements (BIS) a 'Zombie Firm' is generally defined as a company that is unable to generate enough profit to cover its debt servicing costs over an extended period. These inefficient firms survive at least partially thanks to supportive fiscal policies and/or low interest rates. Admittedly, this perspective is incomplete, as it overlooks the rise of private markets, which have played a significant role in the proliferation of zombie companies. Just as our oversized Halloween group started asking too much of individual households, zombie firms consume resources and space in the economy that could be better used elsewhere, creating inefficiencies that drag down the broader system. And the trend of large stakeholders— both consumers and corporations—seeking implicit and explicit protection from the state or monetary authorities is becoming increasingly evident.

‍

These inefficient firms survive thanks to fiscal policies and low interest rates. But like a crowd of Halloween zombies, these firms take up space and resources that could be better used elsewhere, creating inefficiencies in the broader economy. And the trend of large stakeholders— both consumers and corporations—seeking implicit and explicit protection from the state or monetary authorities is becoming increasingly evident.

‍

This 'protection' places an uncompensated burden on the government’s accounting, leading to rising fiscal deficits. Between 2019 and 2024, US federal debt rose from 90 to 124 percent of GDP. Even in Germany (where debt is low by international standards), the figure has risen from 60 to 64 percent. Through these two channels (consumers and corporations), the government is effectively supporting the economically successful segments of society and the corporate world, while the rest is placed under a form of state protection, akin to conservatorship.

‍

‍

Admittedly, this perspective is incomplete, as it overlooks the rise of private markets, which have played a significant role in the proliferation of zombie companies. While it is natural for a responsible state to support the weaker segments of society, it raises the question of whether such support should extend to corporations. Propping up underperforming companies could undermine competitiveness in the medium to long term.

‍

We are undeniably moving toward a market environment characterised by increasing concentration, with a few large companies dominating and driving stock indices to record highs. At the same time, weaker companies continue to survive, even though, in a fully efficient and competitive market, they might not have. Almost a third of US Russell 3000 firms are unprofitable, while more than a quarter are not generating enough cash to cover their interest rate expenses.

‍

This is not merely a neutral phenomenon—these 'zombie' companies tie up human and financial capital that could be better allocated to more efficient businesses and sectors. Their survival distorts resource allocation, affecting other stakeholders and potentially limiting broader economic efficiency.

‍

Society is increasingly seeking protection

‍

More concerning is that this support requires increasing fiscal resources, further burdening government budgets and contributing to rising deficits. This pattern of state intervention extends beyond corporations; it also affects workers. OECD economists find that zombie firms have lower productivity, and tie workers to jobs that are a bad match to their skills. In Europe, the number of fiscally dependent workers is growing. In many countries, union-negotiated wages and legally mandated minimum wages have risen faster than market wages, further illustrating how protectionism, both corporate and labour, is altering economic dynamics on a global scale

.

Meanwhile, high-end workers have seen substantial wage and wealth growth, exacerbating inequality. This has led to relative gains for both the bottom quartile and top earners, often at the expense of the middle class. Consequently, voters for parties like Le Pen, Vox, or AfD are increasingly urban, representing a segment of the societal middle class. These voters seek government protection, despite often holding less extreme political views than the parties they support.

‍

Society is increasingly seeking "protection"—whether through reduced immigration, regulatory support, or financial aid—which, in extreme cases, effectively amounts to competition denial. The very forces driving this transformation, rooted in protectionist and anti-competitive attitudes, paradoxically coexist with a bull market in risky assets such as equities (fuelled by fiscal stimulus and structural transformation) and corporate credit (propped up by survival-biased policy interventions).

‍

Healthy market economies need competition

‍

In a healthy market economy, competition drives innovation and growth. But as more companies and voters seek shelter from competition, we see rising market concentration. Large firms dominate industries, and 'zombie' firms survive through low rates and government aid. Politically, more voters reject competition, supporting populist parties for protection from globalization.

‍

‍

This competition denial should, theoretically, suppress growth and profitability. I’m not overlooking the remarkable technological advancements, especially in AI, that are driving some sectors forward. However, this progress is negatively correlated with the rise of "big government" policies, and it is geographically uneven.

‍

The irony lies in the fact that the same conditions—easy money policies, fiscal support, and low interest rates—are fuelling a bull market in risky assets. As central banks cut rates and governments maintain fiscal support, asset prices continue to rise and may do so as long as fiscal policy remains expansionary.

‍

The disconnect between economic realities and asset prices

‍

The implicit message is clear: As state protection for both companies and consumers increases, competition weakens. Yet, financial markets—propped up by easy money and fiscal stimulus—continue to thrive, creating a dangerous disconnect between economic realities and asset prices. The result is a distorted market where inflated asset prices obscure deeper structural issues—issues that will eventually need to be addressed if real, sustainable, and less deficit-dependent growth is to return.

‍

While core inflation is easing in major economies, core service inflation remains stubbornly high, closely tied to labour market dynamics. Demographic changes are slowing labour force growth, and with rising societal demands for reduced immigration, this worker pool may shrink further, leading to wage pressures and persistent service inflation in the medium to long term. Without broad adoption of AI, Europe faces a sustained challenge in managing rising labour costs.

‍

On the corporate side, market concentration is growing, equity markets are rising, and the number of struggling “zombie” companies is increasing. On the consumer side, rising inequality and the scarcity of human capital mirror these corporate challenges. Just as more companies face difficulties competing, voters seem to be moving toward a stance of competition denial.

‍

A bull market with shaky foundations

‍

‍

Despite these trends, inflationary pressures are fuelling a bullish case for risky assets like equities and credit. While fiscal policies sustain demand, the foundation of this market remains precarious.

‍

The implicit denial of competition in parts of society and the economy suggests that significant changes could unfold in the next five to ten years. As central banks respond to disinflation by lowering interest rates and fiscal policy remains supportive, societal discontent may drive rapid change. The idea of a "roaring 20s" revival no longer seems far-fetched. Major transformations often benefit equity and credit markets as capital demands rise.

‍

Urgent change is particularly needed in Europe. Mario Draghi’s recent report warns that Europe risks falling behind in competitiveness, and it’s not just about technology. German politicians now openly urge their people to 'work harder.' The tension between social welfare and competitiveness is set to escalate, with Europe heading into 'overtime' on this front.

‍

Who will absorb the government debt?

‍

As a Fixed Income professional, I remain aware of the risks and opportunities arising from rapid societal and economic transitions, as well as increased budget deficits. A common question is: who will absorb the additional government debt? Given regulatory incentives for banks and large institutions to hold government bonds, I’m not concerned about their capacity to absorb it. However, my concern lies with the broader market, which may face a government bond curve incorporating a credit risk premium, making sovereign bonds a competitive alternative to riskier assets.

‍

Rising term and credit risk premiums in government bonds can distort risk pricing across asset classes. Consequently, I carefully consider these potential shifts when making investment decisions, particularly regarding bond portfolio duration. A steeper yield curve doesn’t always indicate rising growth and inflation expectations—it can also reflect escalating government funding needs or increased credit risk, acting as an additional burden on the economy.

‍

Both in life and economics, unchecked growth can lead to inefficiencies. Just as the Halloween crowd needed limits to stay manageable, economies need boundaries that encourage competition, ensuring growth that benefits society as a whole.

‍