The Productivity Commission’s Business Dynamism Inquiry – Are We Asking the Wrong Insolvency Questions?

The Australian insolvency profession is currently focused on the Productivity Commission’s Inquiry into Business Dynamism. The interest is understandable. Insolvency and restructuring are expressly identified as matters relevant to the Inquiry and stakeholders have been invited to make submissions.

This is not another review of Australia’s insolvency laws. That is not what the Productivity Commission is doing.

A Different Inquiry

The insolvency profession has become accustomed to parliamentary and government reviews that focus directly on insolvency law and practice.

Most recently, the Parliamentary Joint Committee on Corporations and Financial Services examined whether Australia’s insolvency framework was functioning effectively. That Inquiry considered matters such as liquidator remuneration, assetless administrations, phoenix activity, voluntary administration, safe harbour and regulatory oversight.

Those are important issues.

The Productivity Commission’s Inquiry appears to be asking a different question.

The focus is not primarily whether insolvency law works.

The focus appears to be whether Australia’s legal, regulatory and economic framework promotes or hinders business dynamism.

Business dynamism is the continual process through which businesses are formed, grow, restructure, change ownership and ultimately exit the market. Economists often describe this process as the replacement of less productive activity by more productive activity.

Viewed through that lens, insolvency is not the destination of the discussion. Insolvency is one part of a much larger economic system.

Why Insolvency Matters to Business Dynamism

A modern economy requires mechanisms that allow both success and failure.

Businesses must be able to enter markets, obtain capital, employ people and compete. Equally, businesses that are no longer viable must be capable of restructuring or exiting efficiently.

Insolvency law sits at the intersection of those competing objectives.

A poorly functioning insolvency system can trap capital, labour and entrepreneurial effort in businesses that are no longer economically viable. At the same time, an overly harsh system can discourage risk-taking, innovation and investment.

The challenge is to strike an appropriate balance.

A successful insolvency framework should:

• facilitate the rescue of viable businesses;
• allow non-viable businesses to exit efficiently;
• maintain confidence in credit markets;
• deter misconduct;
• encourage responsible entrepreneurial risk-taking; and
• support the efficient reallocation of resources throughout the economy.

These are economic objectives as much as legal objectives.

The Influence of Economic Thinking

The broader economic focus of the Inquiry is unsurprising.

The Inquiry emerges at a time when government policy is increasingly concerned with productivity growth, competition, entrepreneurship and economic renewal.

Assistant Minister for Productivity, Competition, Charities and Treasury, Dr Andrew Leigh, has been a prominent advocate for examining insolvency through the lens of economic dynamism. His public commentary has focused on second chances, entrepreneurship and the role that insolvency systems play in encouraging innovation and risk-taking.

This represents a subtle but important shift in emphasis.

Historically, insolvency reform discussions have often centred upon creditor recoveries, procedural efficiency and regulatory compliance.

The current debate appears to be moving towards broader questions:

• Does fear of failure discourage entrepreneurship?
• Are viable businesses restructuring early enough?
• Are non-viable businesses remaining in the economy for too long?
• Are capital and labour being reallocated efficiently?
• Does Australia’s insolvency framework support economic renewal?

These are questions economists ask.

What Might the Productivity Commission Be Interested In?

Several issues may become increasingly important.

The first concerns business formation. Does Australia’s insolvency regime encourage individuals to take commercial risks, or does it discourage entrepreneurship through fear of failure? Should business formation require as a pre-requisite education in duties, responsibilities, financial and non-financial issues related to business strategy and implementation of strategy, monitoring budget to actual performance regularly and through different stages of growth.

The second concerns business rescue. Are restructuring mechanisms such as voluntary administration, deeds of company arrangement and small business restructuring preserving viable businesses?

The third concerns market exit. Are failed businesses leaving the market efficiently, or are resources becoming trapped in unproductive enterprises?

The fourth concerns competition. Does the restructuring framework inadvertently provide advantages to some businesses over others, particularly where distressed businesses restructure and continue operating without achieving long-terms viability.

Finally, there is the question of whether Australia’s personal and corporate insolvency systems should continue to be viewed as entirely separate frameworks, particularly in the SME sector where the fortunes of a company and its owners are often inseparable.

These are economic questions.

Looking Beyond Insolvency

The insolvency profession has an important contribution to make to this debate.

Practitioners understand business failure, restructuring and market exit better than most. They see first-hand why businesses succeed, why they fail and what happens when distress is addressed too late.

The Productivity Commission appears not simply to seek technical insolvency reform proposals.

The Inquiry appears to be concerned with something broader.

The central issue may not be whether insolvency law functions effectively as a legal process.

The central issue may be whether Australia’s insolvency framework contributes to the efficient operation of the economy itself.

If that is the question, then the discussion extends well beyond liquidations, voluntary administrations, small business restructuring and safe harbour.

It becomes a discussion about productivity, competition, entrepreneurship, business renewal and economic growth.

Concluding Observations

The Productivity Commission’s Business Dynamism Inquiry may ultimately become one of the more significant policy reviews.

Not because it is an insolvency inquiry.

But because it is an inquiry into the economic environment in which insolvency operates.

For insolvency practitioners, lawyers, accountants, lenders and policy-makers, that distinction matters.

The debate may no longer be whether insolvency law works.

The debate may be whether insolvency law is helping Australia build a more dynamic and productive economy.

David Levi is an experienced Registered Liquidator specialising in restructure and insolvency across a broad range of industries. Accessible and available to accounting firms, law firms, lenders, directors and company secretaries to navigate formal or informal outcomes for companies in financial distress.