Can a business failing actually be good for the economy? Most people see a business closing its doors as a sign of trouble. Financial commentator Michael Pascoe argues the opposite. He suggests that for the Reserve Bank of Australia (RBA) to finally get inflation under control, we need to see more company failures, not fewer. It is a harsh idea, but one based on how markets stay healthy.
The RBA has two main jobs. It must keep prices stable and ensure full employment. Right now, high inflation makes the first job very hard. Pascoe’s view is that our economy is still too "hot." He believes that some businesses are only surviving because money has been too cheap for too long. If these businesses fail, it might actually help the RBA reach its goals.
This article looks at Pascoe's theory. We will break down the logic of creative destruction, examine why current conditions kept some weak companies alive, and look at the real impact this has on the average person and the Australian economy.
The RBA's Inflation Fight and the "Creative Destruction" Argument
The RBA's Mandate and Current Challenges
The RBA has a specific target for inflation. They want to keep the Consumer Price Index (CPI) increases between 2% and 3% over time. When inflation sits well above this range, the cost of living jumps, and the economy gets unbalanced. To fix this, the RBA raises interest rates. High rates make borrowing expensive, which is meant to slow down spending.
The current climate in Australia is difficult. Inflation has proven stubborn. The RBA faces a tough choice: raise rates high enough to kill inflation, or keep rates lower to avoid a recession. Pascoe suggests the RBA cannot win this fight while the economy remains propped up by companies that should have closed their doors years ago.
Pascoe's Thesis: The Necessity of Business Failures
Michael Pascoe points out that the economy lacks the "heat" removal it needs. When interest rates were near zero for years, even poor businesses could borrow money to stay open. Pascoe argues that these companies are not contributing to real growth. They are just occupying space, labor, and capital that better businesses could use.
In his commentary, Pascoe suggests that market discipline is missing. If a company cannot make a profit without cheap debt, it is not efficient. According to this view, these companies need to exit the market. When they fail, it is not a tragedy for the economy; it is a correction.
Economic Theory: Creative Destruction in Action
Economist Joseph Schumpeter coined the term "creative destruction." He argued that for an economy to grow, old and inefficient structures must die. This allows new, more productive companies to take their place. Think of it like a forest fire in nature. It looks destructive, but it clears out dead wood and makes room for new life to grow stronger.
Pascoe’s argument follows this theory closely. If the government and the RBA keep inefficient firms alive, they stop the natural cycle of the market. True economic growth requires this cycle to function. Without the failure of the old, the new cannot thrive.
Why Current Conditions Might Be Stifling Necessary Failures
The Role of Low Interest Rates and Stimulus
For a long time, money was almost free. During the pandemic, the government pumped billions into the economy to keep businesses afloat. While this saved jobs during a crisis, it had a side effect. It created "zombie companies." These are businesses that are not truly profitable and only survive because they can pay interest on their debt. They act as a drag on the economy because they do not improve, they just survive.
The "Fear of Missing Out" and Investment Bubbles
Cheap money also created bubbles. Investors, worried about missing out on gains, poured cash into risky projects. This kept some companies alive that had bad business models. Pascoe would likely argue that we are now seeing the result of this. There is a reluctance to let these investments fail, even though they have clearly not worked out. This creates a market where asset prices stay high and companies refuse to accept reality.
Government Support Mechanisms
Government support was essential when shops were forced to close. However, these programs also distorted the market. They masked the true health of businesses. As these programs ended, many expected a wave of insolvencies. That wave has been smaller than many predicted. While this sounds good, it means the market has not yet cleared out the companies that are not built for a high-interest rate environment.
The Benefits of Increased Company Failures for the RBA
Reallocating Resources More Efficiently
When a business fails, its assets do not just disappear. Its staff, factory space, and machinery become available. In a healthy economy, these resources move to companies that are making money. This is the key to productivity. If a failing company holds onto staff and equipment, those resources are locked away and cannot be used by a business that is actually growing and serving customers well.
Reducing Demand-Side Inflationary Pressures
Inflation often happens when demand is higher than supply. If companies are failing, they stop buying goods and hiring workers at high wages. This cools down the demand side of the economy. By reducing the number of firms bidding up prices for materials and labor, the broader inflationary pressure decreases. This gives the RBA the help it needs to bring inflation back to its target.
Encouraging Innovation and Productivity
Competition forces companies to be sharp. When inefficient firms fail, the survivors must work harder to stay relevant. They look for new ways to save money, improve products, and serve customers. A market with a healthy turnover of businesses is one that innovates. This productivity growth helps keep prices down over the long term, which is the ultimate goal of the RBA.
The Human and Economic Costs of Pascoe's Prescription
Impact on Employment and Livelihoods
This is the hardest part of the argument. Business failures mean job losses. For the people involved, this is not just an "economic statistic"—it is a loss of income and stability. Pascoe’s view is cold and logical, but it ignores the very real pain of workers who did nothing wrong. Policymakers have to weigh this human cost against the need for a stable economy.
Strain on Financial Institutions
If a large number of companies fail at once, banks will see a spike in "bad debts." This puts pressure on the financial sector. If the banking system gets too stressed, it can stop lending to healthy businesses, which makes the economic problem worse. This is why the RBA has to manage this process carefully. They want "some" failure, but not a total collapse.
Regional and Sectoral Disparities
Business failures do not happen evenly. In some regional towns, a single large business might employ a huge chunk of the population. If that business fails, the entire town suffers. This can lead to localized depression that lasts for years. While the national economy might benefit from the "pruning" of inefficient firms, the local impact can be devastating. Targeted help for these areas is often needed to manage the fallout.
Navigating the Path Forward: Policy Implications and Business Strategies
The RBA's Balancing Act
The RBA has a difficult task. They must raise rates to kill inflation, but they cannot raise them so high that they break the economy. They rely on the market to do some of the work. If the RBA keeps rates high for too long, they risk causing more damage than necessary. They have to watch the data constantly to see if the "creative destruction" is working or if the economy is simply shrinking.
Government's Role in Mitigation
The government should not try to save every failing company. That defeats the point of the market cycle. Instead, they should focus on the people. If companies fail, the government should provide support to help workers find new roles. This is called "active labor market policy." It moves people from failing businesses to growing ones, rather than keeping them stuck in jobs that have no future.
Business Resilience and Adaptation
If you run a business, you need to prepare for a tougher market. You cannot rely on cheap credit anymore.
- Strengthen your cash flow: Focus on liquid assets. Do not lock yourself into debt that relies on low-interest rates.
- Know your core value: If your business does not solve a real problem for customers, it will be the first to go. Focus on what you do better than anyone else.
- Invest in efficiency: Don't just hire more people. Use technology to get more output from the team you have.
- Diversify: Do not rely on one big client or one product line. Spread your risk so that if one area fails, you do not go down with it.
The economy is going through a change. It is not just about RBA policy; it is about how businesses act.
Michael Pascoe’s point is that a healthy economy is a changing economy. A certain level of business failure is not a sign of defeat—it is a sign of a market that is functioning properly. By allowing inefficient businesses to fail, we free up resources, lower demand-driven inflation, and force the remaining companies to become more productive.
While the human costs of this process are high and require careful management by the government, the logic remains clear. We cannot have a stable, low-inflation economy if we insist on protecting every company from the consequences of their own inefficiency. Sometimes, the most important step forward is to let go of what is not working.
Everyone discusses the unemployment rate that the RBA considers to be "full employment." (Spoiler alert: it is little lower now than it was three months ago, at 4.3%.)
The increase in company failures and bankruptcies needed to get there is something that almost no one notices.
The "highest company failure rate since the GFC" has already made headlines for months, but this year will see a significant increase in that rate.
Furthermore, and this is not a kind way to put it, the RBA and the economy both need things to worsen.
Even worst is yet to come.
When I asked whether the Reserve Bank needed an additional 10% increase in bankruptcies and business failures to meet its inflation target, Reserve Bank Governor Michele Bullock deliberately rejected the word "requires."
"Need," "desire," "like to see," and other such terms are not ones I would use," Bullock stated.
However, what does a name or word mean?
Setting aside the chosen wording, the RBA anticipates that more and more enterprises will fail after being supported by the Australian Taxation Office's credit extension and the Treasury's generously low borrowing rates.
The bank thinks that is beginning to occur. There must be more of it.
Governor Bullock stated that while she did not anticipate a specific increase in company failures, "we are seeing the climb to more regular levels."
The governor's attempt to explain the dilemma of reducing its unemployment projection slightly on Tuesday while simultaneously decreasing its (already weak) economic growth forecast for this year and pointing out that consumption was declining did not address the role of zombie or "propped up" enterprises.
"Interesting query"
According to textbooks, unemployment should increase rather than decrease as a poor economy continues to deteriorate.
She claimed that the state of the labor market was "a very interesting subject" for which she lacked a comprehensive response.
The fact that a large number of newly created employment are in vital sectors like health and education and are therefore not affected by the cycle was one factor. When the labor shortage was at its worst, there were rumors that companies were barely able to hire the workers they had been searching for. There may have also been some "labor hoarding," where employers held onto employees they might have let go of because they did not want to be caught short if business picked up, as happened after COVID.
The word "unemployment" is simple. I find the RBA's preference to use the term "full employment" rather than the non-inflation-accelerating rate of unemployment (NIARU) to be a bit euphemistic and a way to avoid discussing a number that the bank has only learned about after the fact.
The unemployment rate that the bank believes is compatible with bringing inflation down into its goal zone of 2 to 3 percent in the second half of next year was announced in Tuesday's quarterly statement on monetary policy. It was 4.3%, which was one percentage point lower than what it had predicted three months prior.
However, the necessary business failure rate is not specified and does not seem to be predicted.
Therefore, it would seem realistic to predict a 10 percent increase in employers failing from the "more normal levels" we are currently witnessing, especially if the RBA aims to raise the unemployment rate by 10 percent from here.
However, the RBA does not "expect" such actions. Instead, euphemisms are used to hide the advantages of enterprises failing.
The productivity conundrum
The SoMP attributed a portion of the poor productivity growth to "slowing labor and capital reallocation." The governor acknowledged that in order to increase productivity, "enterprise dynamism" is necessary.
All of it means that the marginal, least productive enterprises will fail, go bankrupt, and free up labor and capital for new and more productive businesses.
The business cheer squad, in particular, prefers to overlook the hard fact that eliminating the least productive people is the best way to increase productivity.
Stories of growing failures are invariably framed as some sort of failure of government policy, rather than being truthfully presented as an essential component of the Darwinian phenomenon that is capitalism, however tragic and painful it is for the individual business owners.
One aspect of the monetary policy transmission mechanism that is less discussed is sending businesses bankrupt.
"A lot of money went out the door from the government to support households and businesses in the pandemic," the governor said. Businesses' overall balance sheets improved significantly, coverage rates improved, and debt servicing decreased in tandem with the historically low interest rates.
Businesses that were supported by RBA and Treasury policies are now beginning to run out of support, and the ATO is pursuing repayment of loans that were allowed to run.
0 Comments