Swinging the axe

Job-cutting has begun in earnest. But will the axe be wielded wisely?

THE headlines screamed that January 26th was “Black Monday” for jobs, after firms such as Caterpillar, Corus, Home Depot, ING, Pfizer and Sprint Nextel announced cuts of several thousand jobs each, due mostly to the rapidly deteriorating global economy. Alas, the consensus among the corporate bigwigs gathered this week at the World Economic Forum in Davos was that this marked only the beginning of the axe-swinging, and that there are blacker days to come.

This proved to be one of the big points of difference between the company bosses and the politicians brainstorming in the mountains. The politicians are primarily concerned with restoring demand enough to reverse the rising trend in unemployment; for many of the corporate leaders, ensuring the survival of their firms takes precedence over saving jobs. The difficult decision they face is not whether to cut, but how to do so in a way that strengthens their competitive position in the medium term rather than seriously damaging it.

The gloomy mood among bosses in Davos makes the worst-case scenario outlined in a new forecast from the International Labour Organisation (ILO) seem the most plausible of its possible outcomes. This supposes that if every economy in the developed world performs as it did in its worst year for unemployment since 1991, and every other economy performs half as badly as in its worst year, then the global jobless rate will rise to 7.1% this year—some 230m people, up from 179m in 2007.

The ILO’s most optimistic prediction is that global unemployment will rise only to 6.1% (from 6% in 2008). But that assumes that the world economy performs as the IMF forecast in November: global GDP growth of 2.2% in 2009, with a slight recession in the developed economies. The IMF has since become much glummer: this week it forecast growth of just 0.5%.

Already, firms are starting to find that their first round of cuts after the onset of the crisis is not enough. Caterpillar’s latest cut of 5,000 jobs is in addition to 15,000 already announced. Such is the frenzy of cutting that Challenger, Gray & Christmas, a recruitment firm that tracks employment trends in America, sought a crumb of comfort in its finding that over 50% of firms have cut jobs: it proclaimed in its latest report that “nearly half of employers avoid lay-offs.” But it pointed out that things would be even worse without the various innovative schemes adopted by companies to reduce labour costs without shedding jobs. These include salary cuts, reduced hours and “forced vacations”.

As Challenger suggests, this seems in keeping with the suggestion by Barack Obama in his inauguration speech that people should “cut their hours [rather] than see a friend lose a job.” Already, by way of example, White House staff earning $100,000 or more have had their salaries frozen. Companies including Avis, Starbucks and Yahoo! have announced pay freezes for 2009.

Yet these creative job-saving schemes are unlikely to go anywhere near as far as Mr Obama would like. They may appeal as a way to buy some time as companies try to get a clearer picture of where the economy is heading, or to retain talented workers who are likely to be needed in the future, if not now. But they have little appeal once a firm has decided that it needs to scale back its operations. As the boss of a big American retailer put it privately at Davos, “We have to decide who we want on the bus and to motivate them as much as possible.” Clever ways to share the pain can demotivate everyone, especially if they are seen as merely postponing the inevitable job cuts, making everyone fearful.

Painful choices

Equally candidly, many bosses admit that the crisis is giving them a chance to restructure their firms in ways that they should have done before, but found a hard sell when things were going well. As a rule of thumb, a careful cull of the 10% of lowest performers can make a firm leaner by removing fat without damaging muscle. It is going beyond the 10%, as many firms are now starting to do, that poses the real risks to a firm’s competitiveness.

During the relatively modest downturn at the start of this decade, for example, many professional-services firms cut too deeply, especially in their lower ranks, and found they were poorly positioned when strong growth resumed sooner than expected, says Heidi Gardner of Harvard Business School. Firms built on pyramid structures in which senior managers mentored larger numbers of employees below them suddenly found that, in a growing economy, they lacked the mentors needed to manage the army of new recruits. Instead, they had to re-hire ex-staffers at higher salaries and, in some cases, abandon proven policies of hiring senior managers only from within, says Ms Gardner, who worked for McKinsey at the time.

This crisis is revealing how few firms have really thought through their talent strategies, says Mark Spelman of Accenture. Claims that “our workers are our most valuable assets” are too often platitudes, the emptiness of which is now being revealed. But those firms that have thought seriously about their talent needs have the opportunity to get ahead of those that haven’t, says Mr Spelman, not just by shedding poor performers but also hiring scarce talent from outside, in what is now a buyer’s market. Other tips from Mr Spelman include avoiding voluntary redundancy programmes, which encourage the most employable people to quit, and not firing the newest recruits on a crude “last in, first out” basis, as this cuts off the supply of future talent. Instead, firms should identify which workers they need to keep, and do what they must to retain them.

Governments can play a useful role or a harmful one, depending upon their attitude to companies, says David Arkless of Manpower, an employment-services firm. If they focus on working with firms to smooth the movement of labour to where the future work will be, for example by providing skills training and financial incentives to workers in transition, then the economic downturn could be less painful than now seems likely. (A quick recovery in lending to small businesses, the main drivers of job creation in most countries, would also help.) But if governments try to prevent firms from making the changes to their workforces that they want, the result is likely to be prolonged gloom.

Although Mr Obama’s support for strengthening the ability of unions to enter workplaces is arguably a worrying sign, the American economy is far more accommodating of flexibility in employment than many European countries. Mr Arkless, for one, says that without a dramatic change of attitudes to job-cutting in Europe, “there is no doubt that American firms will come out of this downturn better than anywhere else in the world, due to their flexible employment model.” This will provide no comfort to anyone facing the prospect of unemployment, but it is a message that politicians would do well to take to heart.

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Big government fights back

FEW now doubt that the world economy is in its most parlous state since the 1930s.

Demand is slumping across the globe as firms and consumers are battered by a pernicious, self-reinforcing bombardment of dysfunctional financial markets, falling wealth, higher unemployment and rampant fear. The IMF’s latest forecasts, published on Wednesday January 28th, suggest 2009 will bring the deepest global recession in the post-war era.

To stem the slump, governments are fighting back with an activism rarely seen outside wartime (see interactive graphic). In some countries, notably China, official estimates overstate the likely fiscal stimulus. But even adjusted for bureaucratic hyperbole the government response is hefty. Weighted by their economies’ size, the plans of 11 big advanced and emerging economies are worth an average of 3.6% of GDP—though spread over several years. The IMF expects tax cuts and spending worth 1.5% of global GDP to kick in this year.

In many rich countries the stimulus has been matched—and often dwarfed—by the upfront costs of financial rescues, including the recapitalisation of banks and guarantees for troubled assets. America’s Treasury has so far promised about $1 trillion (7% of GDP) for the finance industry.

Add in the tax revenues lost from slumping output and falling asset prices as well as the spending on higher unemployment benefits, and the IMF expects rich countries’ combined fiscal deficit to rise to 7% of GDP in 2009, up from less than 2% in 2007. By the end of this year the developed world’s gross government debt, as a share of GDP, may be 15-20 percentage points higher than it was two years ago.

Emerging economies are spilling less red ink, both because their banking industries are in less of a mess and because their stimulus plans, in general, are smaller. But they, too, will shift from a budget surplus in 2007 to a deficit of 3% of GDP. All told, public-sector debt is rising at its fastest pace since the second world war.

Most economists agree that the red ink is both unavoidable and appropriate. To prevent a steep recession becoming a depression, governments must step in to forestall financial collapse and counter the slump in private demand. Financial markets seem to agree. Yields on government bonds in most rich countries are extremely low as shell-shocked investors clamour for the safety of public debt.

Yet a few signs of skittishness are emerging. Prices of credit-default swaps on sovereign debt have risen sharply, suggesting that investors see growing risks of default. Within the rich world, risk premiums have risen dramatically for already-indebted governments such as those of Greece and Italy. Yields on America’s 30-year bonds saw their biggest jump in two decades in mid-January, as investors fretted about Uncle Sam’s demand for cash.

This skittishness partly reflects uncertainty about how the government debt will be financed. But the real worry is that the ultimate public price tag will be much bigger than today’s figures suggest.

That seems plausible. Large as they are, the immediate costs of the financial clean-ups seem modest against the scale of the banking mess and costs of previous banking crises. So far America’s government has put less than half as much public money into the financial sector, relative to the size of its economy, as Japan did in the 1990s. More will be necessary if, as is rumoured, Barack Obama’s team creates a bad bank to take on troubled loans and puts more capital into banks. Goldman Sachs recently estimated that the total value of troubled American bank assets was $5.7 trillion; that makes an initial cost of several trillion dollars seem possible.

The net cost—and hence the net addition to long-term public debt—will be much smaller. On average, the IMF reckons, rich countries recover half their outlays for financial rescues. Sweden, whose banking rescue is seen as a model, recouped more than 90%. America may eventually manage something close to that, but the initial investment must be big.

Relax and spend

Unfortunately, the political cost of bailing out bankers and the huge sums involved mean that many politicians in rich countries are loth to spend heavily. History suggests that is a mistake. Failure to mend a broken financial system quickly means a longer recession; it also renders fiscal stimulus much less potent. Contrast Japan, which had numerous fiscal-stimulus packages in the 1990s, but failed to emerge from its slump until its debt problem was finally dealt with, with South Korea in 1997, which spent 13% of GDP on a large, speedy bank-rescue package.

The fiscal costs of that error can be enormous. In a recent paper Carmen Reinhart of the University of Maryland and Ken Rogoff of Harvard University estimated that the big banking crises of the post-war period, on average, raised real public debt by more than 80% of GDP. Most of that rise came not from financial rescues but from prolonged recessions and the fiscal expansions designed to combat them. Even this year, half the deterioration of the rich world’s deficits has stemmed from economic weakness.

If fiscal stimulus is no substitute for financial clean-ups, it is an important support at a time of slumping demand. But much depends on how well the plans are structured. All the big economies foresee some tax cuts, particularly for individuals. (Only a few, including Canada and Russia, plan to cut corporate taxes.) But the focus of the global fiscal boost is on spending, particularly on infrastructure.

Economic theory suggests that makes sense. When firms and consumers are gripped with uncertainty, government spending is a surer way to boost demand. Consumers and firms might save the money. The empirical evidence, however, is less than conclusive. Economists’ estimates for the “multiplier” effect of government spending and tax cuts vary widely, with equally reputable studies showing opposite results. More important, the scale of the global slump means that historical multipliers may not mean very much. That suggests a broad strategy—involving both tax cuts and spending—is prudent.

Less sensible, however, is the distribution of stimulus between countries. America’s fiscal package, at $800 billion or more, will be by far the biggest in absolute terms and one of the biggest relative to the size of its economy. Lamentably, rich creditor countries, such as Germany, are doing much less. In the emerging world China’s boldness is laudable, and fat reserve cushions have also given other emerging economies more room. But many will find their ability to borrow constrained by investors’ flight from risk—and the surge in public debt in the rich world. In its latest estimates, the Institute of International Finance, a bankers’ group, expects private-capital flows to emerging economies of only $165 billion this year, down more than 80% from 2007.

If politicians dither over bank rescues, if countries that can stimulate safely do not do enough, and if fearful investors shy away from emerging markets, the odds of a lasting recovery of the global economy seem slim. And that, in turn, will mean far bigger rises in public debt. A multi-year downturn could easily send government-debt ratios up by 30% of GDP or more.

This need not be calamitous. Governments can work off huge debt burdens without default or high inflation. During the second world war, for instance, Britain’s gross debt burden rose above 200% of GDP; America’s topped 120%. During the 1990s, fast growth and fiscal prudence allowed countries from Ireland to Canada to cut their debt levels sharply.

The difference this time is that the rich world already faces the costs of an ageing population, which promise a fiscal burden many times greater than even the darkest scenarios for the financial crisis. Right now fiscal activism is indispensable, but the consequences will be bigger and longer-lasting than many realise.

www.economist.com

FEW now doubt that the world economy is in its most parlous state since the 1930s.

Demand is slumping across the globe as firms and consumers are battered by a pernicious, self-reinforcing bombardment of dysfunctional financial markets, falling wealth, higher unemployment and rampant fear. The IMF’s latest forecasts, published on Wednesday January 28th, suggest 2009 will bring the deepest global recession in the post-war era.

To stem the slump, governments are fighting back with an activism rarely seen outside wartime (see interactive graphic). In some countries, notably China, official estimates overstate the likely fiscal stimulus. But even adjusted for bureaucratic hyperbole the government response is hefty. Weighted by their economies’ size, the plans of 11 big advanced and emerging economies are worth an average of 3.6% of GDP—though spread over several years. The IMF expects tax cuts and spending worth 1.5% of global GDP to kick in this year.

In many rich countries the stimulus has been matched—and often dwarfed—by the upfront costs of financial rescues, including the recapitalisation of banks and guarantees for troubled assets. America’s Treasury has so far promised about $1 trillion (7% of GDP) for the finance industry.

Add in the tax revenues lost from slumping output and falling asset prices as well as the spending on higher unemployment benefits, and the IMF expects rich countries’ combined fiscal deficit to rise to 7% of GDP in 2009, up from less than 2% in 2007. By the end of this year the developed world’s gross government debt, as a share of GDP, may be 15-20 percentage points higher than it was two years ago.

Emerging economies are spilling less red ink, both because their banking industries are in less of a mess and because their stimulus plans, in general, are smaller. But they, too, will shift from a budget surplus in 2007 to a deficit of 3% of GDP. All told, public-sector debt is rising at its fastest pace since the second world war.

Most economists agree that the red ink is both unavoidable and appropriate. To prevent a steep recession becoming a depression, governments must step in to forestall financial collapse and counter the slump in private demand. Financial markets seem to agree. Yields on government bonds in most rich countries are extremely low as shell-shocked investors clamour for the safety of public debt.

Yet a few signs of skittishness are emerging. Prices of credit-default swaps on sovereign debt have risen sharply, suggesting that investors see growing risks of default. Within the rich world, risk premiums have risen dramatically for already-indebted governments such as those of Greece and Italy. Yields on America’s 30-year bonds saw their biggest jump in two decades in mid-January, as investors fretted about Uncle Sam’s demand for cash.

This skittishness partly reflects uncertainty about how the government debt will be financed. But the real worry is that the ultimate public price tag will be much bigger than today’s figures suggest.

That seems plausible. Large as they are, the immediate costs of the financial clean-ups seem modest against the scale of the banking mess and costs of previous banking crises. So far America’s government has put less than half as much public money into the financial sector, relative to the size of its economy, as Japan did in the 1990s. More will be necessary if, as is rumoured, Barack Obama’s team creates a bad bank to take on troubled loans and puts more capital into banks. Goldman Sachs recently estimated that the total value of troubled American bank assets was $5.7 trillion; that makes an initial cost of several trillion dollars seem possible.

The net cost—and hence the net addition to long-term public debt—will be much smaller. On average, the IMF reckons, rich countries recover half their outlays for financial rescues. Sweden, whose banking rescue is seen as a model, recouped more than 90%. America may eventually manage something close to that, but the initial investment must be big.

Relax and spend

Unfortunately, the political cost of bailing out bankers and the huge sums involved mean that many politicians in rich countries are loth to spend heavily. History suggests that is a mistake. Failure to mend a broken financial system quickly means a longer recession; it also renders fiscal stimulus much less potent. Contrast Japan, which had numerous fiscal-stimulus packages in the 1990s, but failed to emerge from its slump until its debt problem was finally dealt with, with South Korea in 1997, which spent 13% of GDP on a large, speedy bank-rescue package.

The fiscal costs of that error can be enormous. In a recent paper Carmen Reinhart of the University of Maryland and Ken Rogoff of Harvard University estimated that the big banking crises of the post-war period, on average, raised real public debt by more than 80% of GDP. Most of that rise came not from financial rescues but from prolonged recessions and the fiscal expansions designed to combat them. Even this year, half the deterioration of the rich world’s deficits has stemmed from economic weakness.

If fiscal stimulus is no substitute for financial clean-ups, it is an important support at a time of slumping demand. But much depends on how well the plans are structured. All the big economies foresee some tax cuts, particularly for individuals. (Only a few, including Canada and Russia, plan to cut corporate taxes.) But the focus of the global fiscal boost is on spending, particularly on infrastructure.

Economic theory suggests that makes sense. When firms and consumers are gripped with uncertainty, government spending is a surer way to boost demand. Consumers and firms might save the money. The empirical evidence, however, is less than conclusive. Economists’ estimates for the “multiplier” effect of government spending and tax cuts vary widely, with equally reputable studies showing opposite results. More important, the scale of the global slump means that historical multipliers may not mean very much. That suggests a broad strategy—involving both tax cuts and spending—is prudent.

Less sensible, however, is the distribution of stimulus between countries. America’s fiscal package, at $800 billion or more, will be by far the biggest in absolute terms and one of the biggest relative to the size of its economy. Lamentably, rich creditor countries, such as Germany, are doing much less. In the emerging world China’s boldness is laudable, and fat reserve cushions have also given other emerging economies more room. But many will find their ability to borrow constrained by investors’ flight from risk—and the surge in public debt in the rich world. In its latest estimates, the Institute of International Finance, a bankers’ group, expects private-capital flows to emerging economies of only $165 billion this year, down more than 80% from 2007.

If politicians dither over bank rescues, if countries that can stimulate safely do not do enough, and if fearful investors shy away from emerging markets, the odds of a lasting recovery of the global economy seem slim. And that, in turn, will mean far bigger rises in public debt. A multi-year downturn could easily send government-debt ratios up by 30% of GDP or more.

This need not be calamitous. Governments can work off huge debt burdens without default or high inflation. During the second world war, for instance, Britain’s gross debt burden rose above 200% of GDP; America’s topped 120%. During the 1990s, fast growth and fiscal prudence allowed countries from Ireland to Canada to cut their debt levels sharply.

The difference this time is that the rich world already faces the costs of an ageing population, which promise a fiscal burden many times greater than even the darkest scenarios for the financial crisis. Right now fiscal activism is indispensable, but the consequences will be bigger and longer-lasting than many realise.

www.economist.com