Why Corporate Downsizing Doesn't Work: The 'Confessions' of Stephen Roach and other Views

Current Issues Brief 21 1995-96

Stephen O'Neill
Economics, Commerce and Industrial Relations Group



Economic growth and productivity

Downsizing - what does it mean?

The 'confessions'

The Sampson View

The changing rules of corporate governance

Implications for living standards and growth




How can the process of economic growth be managed so that it delivers more jobs and higher living standards through real wage increases? An answer usually put in response is by improving productivity. This paper reviews the recent controversy sparked by US economist Stephen Roach concerning corporate strategies to achieve higher economic growth and, eventually, higher employment. Formerly influential for his views on corporate restructuring, Mr Roach denounced those methods which required large scale job-shedding and the rationalisation of plants and product lines. He now argues that this form of corporate restructuring or downsizing is not the necessary precondition for delivering either growth of the corporation concerned or of the national economy.

The paper reviews the comments of Mr Roach and other views on downsizing. It outlines the argument that improving productivity is traditionally the basis for rising living standards. It reviews one corporate instrument of increasing productivity in the context of the economic contractions of the 1970s (interpretations of trends in productivity are central to Mr Roach's recantations).

The term 'downsizing' is described and the aspects of the recent controversy are reviewed, since other views have long questioned the wisdom of drastic corporate restructuring. Also, the paper looks at how the rules of corporate governance have changed in the 1980s and 1990s. The change in the operation of these rules, under the scrutiny and influence of an investigative finance industry, indeed helps explains the feeling of 'insecurity' by many in the workforce. The paper concludes with a reassessment of traditional Gross Domestic Product (GDP) measurement of national output and reflects on an alternative calculation which, in the case of the United States, shows that a revised community-oriented measure of GDP may indeed reflect the fall of community well being, whereas the traditional measures tend to imply a benign growth in well-being as the adjunct to rising GDP.

Economic growth and productivity

In Australia, economists tend to rely on economic growth of at least three per cent per year (3% pa) to contain rising unemployment, let alone reduce unemployment(1). This rate of growth is needed merely to offset the combined effects of growth in the labour market and rising productivity.

Productivity, however, is generally regarded as being difficult to measure because a) of giving a value to new capital stock (capital productivity) and b) when agricultural and manufacturing industries decline relative to the growth of the services industries, the task of actually measuring outputs (eg the growth of financial services) against inputs become harder to quantify.

Nevertheless, the question of how to achieve higher levels of productivity has bedevilled public debate since the early 1970s when the 'oil shocks' (significant oil price rises) affected the economics of production in the industrialised economies. Over the post-war period economies in Japan and Europe were reconstructed using modern plant and technology. Since then, the industrialised economies have had many of their markets challenged by the growth economies of Asia.

Improvements to capital and technology and education investments are the essentials. There is no question that economists correlate improving productivity and economic growth. In a nutshell, rising productivity means that the same level of output can be produced with a decreasing number of inputs, releasing these resources to be put to other purposes. This can also be achieved by improvements to the way capital is used through work organisation. To take advantage of new technologies, investment in human capital through education and training represent the prerequisites for improving labour productivity. Reducing inputs, most often labour inputs, is one method which can improve productivity but does it always generate economic growth?

When the (no longer needed) resources have been put to other purposes, on a successful basis, the result is to increase an economy's production of goods and services - ie to increase economic output and with it, jobs. That having been said, improving productivity by itself can be regarded as a double-edged sword. Without economic growth, improving productivity displaces labour, since last year's level of output can be produced this year with less labour inputs. This is what economists mean when they say: ' (the) differential between output and employment growth reflects differential rates of growth in labour productivity'(2).

Without improving productivity, the opportunity of cutting back on the resources currently being directed towards a certain level of production is lost. In turn, the ability to diversify production and undertake the production of new goods and services is also limited. Or, put another way, without increasing productivity, the economy may stagnate.

But how to achieve growth, rising living standards and improving or rising productivity while trying to increase employment (or at the least, not exacerbate unemployment)? This is entree for the role of downsizing the operations of enterprises (including public sector enterprises) and the contribution made to the debate by an influential economist, Stephen Roach, both as a proponent of downsizing but now a convert to what might be called 'considered corporate planning'.

However, the debate over corporate restructuring has always incorporated the views of those who doubted the value of a massive shake-up to an enterprise's activities, in that the loss of skill, corporate memory and loyalty as well as the loss of morale deplete an enterprise's ability to innovate and produce quality products and services(3). Another influential corporate planner, Professor Peter Drucker, has also criticised over-reliance on downsizing with his comment: 'we are seeing too many amputations before diagnosis'. His view, based on US evidence of the results of downsizing, is that too many staff cuts in corporate restructurings have been ill-considered and even inappropriate(4).

Downsizing - what does it mean?

In the 1980s corporate downsizing was proffered as a strategy to restore high productivity, and possibly to restore high economic growth rates. Corporate downsizing is a term which covers a number of managerial practices but predominantly relies on job-shedding as a means to cut costs and to move the operation into profit-centres. A downsizing strategy may require a company to rationalise these centres by improving the technology of particular facilities while downgrading (or eliminating) the roles of others.

For those operations that remain, their activities will be divided into a series of 'core' and 'non-core' activities. The core activities reflect the central purpose of the enterprise and are responsible for generating profits. Core activities require highly skilled and loyal senior staff. Non-core activities (eg office cleaning, transport and stores etc) are considered not central to the company's operations and are often sub-contracted. Sub contracting almost always results in lower remuneration, conditions and job security standards for (the often same) employees who performed those functions prior to downsizing(5). In its more stark form, corporate downsizing (ie within a firm) thus relies on job-shedding to raise profits thereby improving the attractiveness of a company's shares. It may be that employment does not always inevitably fall. Nevertheless the strategy is based less on the company developing quality in its products and services, and relying less on developing products from research and development activity.

The 'confessions'

In May 1996, the conventional wisdom supporting corporate downsizing could be seen to have been delivered a blow when a foremost proponent, Stephen Roach, criticised the practice by way of a memo to clients of the Morgan Stanley bank.

Mr Roach is a leading US economist. He has worked for the US Federal Reserve Bank and currently is a chief economist with the financial institution Morgan Stanley. He has been a leader of the school of thought which promoted a 'productivity led recovery' using corporate downsizing as a means of retaining business competitiveness. In fairness, he assumed that the resources released would be used to boost the role of the services sector.

Nevertheless, Mr Roach has reassessed his views, conceding on Lateline that without getting 'more out of more' (ie more productivity out of growing output), the former approach only hollows out companies without providing general economic growth(6). The text of his memo reads:

For years I have extolled the virtues of America's productivity-led recovery. While I think its safe to say that such a scenario has become the new mantra for US businesses in the 1990s, I must confess that I am now having second thoughts ... these doubts have caused me to rethink many of the glorious consequences that I have long argued would be forthcoming in a truly productivity-led recovery ... Slash and burn restructuring was not a permanent solution. Tactics of open-ended downsizing and real wage compression are ultimately recipes for industrial extinction(7).

He further added:

If all you do is cut you will be eventually left with nothing, with no market share. The myth has been there and I'm guilty of having perpetrated the myth - of the virtue of boosting companies by remaking the corporate entity into a leaner, more flexible and competitive organisation. This was music to the ears of investors but at the end of the day, though some of the things that were done were good, it was wrong.

Its been a powerful learning experience for me because it takes me to the core of what I have been schooled in. And that is that at the end of the day you can create wealth only if you've got a corporate sector that has its act together and takes a long-term strategic view. The debate itself is a healthy one. It goes to the core of what it takes to compete and boost standards of living. Do we get there by growing? Or - which is what we've been doing - by hollowing out companies?(8)

The media reports of Mr Roach's revision have played up the 'he got it wrong' line and the following commentary has been characteristic:

Wall Street's leading guru of 'downsizing', the cult of corporate shrinkage that is wiping out millions of jobs around the world in the name of efficiency has decided that he got it wrong.

Stephen S. Roach, the influential chief economist at Morgan Stanley declared last week that relentless cost cutting was bad for business. If you compete by building you have a future he said, if you compete by cutting you don't - the pendulum has swung back from capital to labour. Companies will have to hire more labour, pay them better and treat them better.

The theory of downsizing swept the world in the 1980s providing business with an intellectual justification for ruthless cost-cutting which left millions out of work and millions overworked. Sacking staff enabled companies to dramatically improve their bottom lines without selling more products(9).

It was not surprising that the conservative economic journals would accept such a juxtaposition without challenge. The Economist for example has been cautious about Mr Roach's statements, arguing that America has produced jobs at a greater rate than for most OECD countries, that 'Mcjobs' are better than no jobs and that any economy takes time to adjust to restructurings. This excerpt from The Economist expands the debate:

Two schools of thought about American productivity have recently been popular. The first noting that America's output per worker is rising only slowly (less than 1% pa since 1980) attribute this not to a dearth of investment (a plausible cause) but to 'hollowing out'. Productivity in parts of manufacturing has grown at a reasonable pace, the argument goes, but the workers shed in the search for growing efficiency have been forced to take low-productivity 'Mcjobs'. Productivity in the economy as a whole has grown far more slowly.

A second school of thought has taken a more optimistic view. The productivity figures for services (now much the largest part of the economy) are misleading. It is impossible to count the output of a law firm, say, in the way you count the output of a car plant. Official figures for output of services show a marked increase, yet it is clear that technology has transformed the amount of work that many workers can do and output and productivity in such industries have most likely been rising faster than statisticians think.

This week, one of the champions of this second school defected. Stephen Roach, a highly regarded pundit at Morgan Stanley, an investment bank, announced that he had been born again as a pessimist. As a result, the view that America is failing now looks more like a consensus than it did before. But is that view correct?

Mr Roach's reasons for changing his mind are unclear. He says he now fears that restructuring may yield only once-and-for-all gains in output, rather than acting as a platform for persistently faster growth in future. So it may prove. But this is not, as he appears to think, to endorse the 'hollowing-out' school. What is productivity growth if not an endless stream of 'restructurings' of different kinds? If the pace of restructuring has accelerated thanks to technology or other causes - and nobody appears to doubt it - then one would expect productivity growth to accelerate in due course for the same reason. This may not last forever, but what does?

Three other points also suggest that America's spirits should not flag too much. First, growth in output per worker is indeed likely to be understated in official figures ... America like many other countries is probably doing better than it thinks. Second, it would not in any case be unusual if the recent burst of rapid technological change turned out for a time to be followed by a sluggish growth in output. Economies take time ... to move displaced workers into new jobs, and more time still to move them into better jobs ... Third, in this crucial task of keeping workers employed in the interim, America's record, although far from perfect, is much better than that of most other rich countries(10).

The Sampson View

Anthony Sampson recently canvassed similar issues to Stephen Roach in his book Company Man, and many of the political consequences of downsizing heralded by Mr Roach had been reviewed in that work(11). But Sampson's approach and emphasis are quite different from that of Stephen Roach.

Sampson's approach is to question the values and principles which corporations have adopted, and looks at downsizing and privatisation from this perspective. His approach reveals a more delicate mix of policy options being offered and traded in the broader political economy. For Sampson, it is the role of status of senior management which is the key variable. In the 1960s, corporate management 'hoarded' employees because the status of management depended on the numbers of employees under their control, with the result that companies were over-staffed. In the 1990s, managerial status is often associated now with the numbers of employees a manager retrenches. Sampson argues (not persuasively) that the salary of managers is now more aligned to the ability to fire people 'The more people he fires, the more he is likely to be paid. That's a very worrying equation'(12).

As with Stephen Roach, Sampson portends a political blacklash from electors over downsizing/job loss for the reason that the pace of change cannot be absorbed by the electorate. The political outcome, he says, could easily be of a fascist mould, although one hastens to add that Sampson is not the first to herald such a direction. Writers such as O'Connor have also canvassed the likely political responses to corporate pressures for reductions in public sector services(13).

Sampson argues that in the global marketplace, employers can pursue profits by substituting casual labour for permanent labour. The result is unemployment as in Europe or the loss of permanent jobs for casual forms of employment as in the United States. Not atypically, Sampson considers that the power of corporations has increased relative to the role of government; this has been brought on by the loss of control over nationalised industries by governments and their reluctance to be involved in managing industries.

So where is the mechanism to deliver full employment? The problem according to Sampson is that:

corporations don't have the long term responsibility for stability and families that government used to have, so that has led to much less secure existence for people. That insecurity is growing the whole time because companies don't want to be landed with the responsibilities for full employment or the old paternalistic responsibilities the corporate [world] used to have(14).

He contends that governments are moving away from their commitments to providing pensions and welfare. Added to this there is the casualisation of labour which ultimately acts to the detriment of companies since the loyalty component in the employment equation no longer functions. Sampson concludes that the Germans and the Japanese have better corporate growth models since corporate practices of both give importance to training, job security and employee welfare. One study of restructurings conducted in Australia has also concluded that the conduct of these exercises has, in general, been reasonable from the viewpoint of staff, but staff can become resentful when the exercise is repeated often, since this indicates that management do not have a thought-out plan(15).

The debate over downsizing and worker insecurity, located as it is now in the context of this year's US elections, has resulted in a barrage of responses (similar to the content of the extract quoted from The Economist) countering the 'pessimist' view that job security is worse, that wages are stagnant and so-on(16).

The changing rules of corporate governance

The controversy brought about by Mr Roach's stance leads into the wider debate of economic measurement and perceptions of security and improving living standards. This issue also touches on major political developments such as the challenge of Pat Buchannan to Bob Dole for nomination as Republican presidential candidate. Mr Buchannan has campaigned on the issue that free trade is injuring the interests of working class Americans; that NAFTA is detrimental to workers' interests and so-on.

A number of reasons are often given for stagnating living standards. These include the deleterious side of free trade and globalisation of production. However, there is now also a focus on the changing rules of corporate governance to explain perceptions of job insecurity and depressed real wages.

Studies by Gary Burtless, an academic with the Brookings Institute in Washington, have attempted to account for various influences on stagnating living standards and 'insecurity'. He argues that there is a new pressure on companies to downsize in the 1990s, when for the same return on assets in the 1960s, the pressure would have been withstood.

The change in the 1990s, he argues, comes from the information-gathering function of the finance and security industries. In the 1960s, when (US) firms responded to falling demand, they laid off staff, then recalled them after the recession. In the meantime wage negotiations addressed the needs of workers who would remain loyal to the company and the resulting wage levels were somewhat less driven by corporate profitability demands. However Burtless believes that the rules applying in the 1960s no longer operate:

... the market for corporate control, and innovations in the market for corporate control, have now made it much more difficult for managers, except in selected firms, to think that they are immune from what the rest of the financial markets thinks of what they are doing. So, for example, if a firm has been running its airline or its manufacturing company in such a way that they are paying their workers comparatively generous wages and they're earning decent profits, that kind of management method could have continued indefinitely in the 1950s, 1960s or 1970s. In the 1990s, ... managers know that unless they adopt a cost-saving measure that makes their corporation even more profitable than it has historically been, they might be removed, their control of the corporation might end because of a hostile takeover bid that wrings costs out of the corporation that it could have lived with in the past(17).

and in respect of cost cutting, Burtless recalls that:

a major cost cutting exercise conducted by a major corporation in the 1960s was often interpreted by financial markets as an indicator that future sales were going to shrink and that the company was in real trouble. Nowadays, firms that are clearly quite profitable and have healthy cash balances often undertake big cost-cutting measures, in which thousands often are slated for removal from company payrolls, and the market interprets that very favourably. It takes it as an indication that the firm has a management committed to wringing costs out of the company, thereby raising its profitability regardless of its prospects for further growth(18).

Implications for living standards and growth

While the contributions of Roach, Sampson and Burtless help explain perceptions of worker anxiety, they do not provide recommendations for a more secure and equitable economic direction given the consequences of downsizing. Moreover the contention of Anthony Sampson that there may arise forms of fascist political solutions because of the opposing responses to (but ongoing pressures for) downsizing, is hard to sustain.

One need only to look at the international demand for the observance of labour standards by the 'new economic tigers' to appreciate that an equally legitimate development from the 'free-trade and loss of jobs' debate in industrialised countries, are pressures (both internal and external) for democratic rights. These include bans on forced child labour, the right to organise and to collective bargaining. In this process for reform, as Kapstein has observed, organised labour in the industrialised countries has given significant support(19).

The downsizing debates also reflect an over-reliance on conventional GDP measures as being accurate indicators of community well-being. The problems of measuring productivity improvements in a services dominated economy have been well reported. In the view of Cobb, Halstead and Rowe, the use of national accounts (very much a post-war development) has given governments and corporations an ability to plan their economies, principally through focusing on areas of slack demand and specifically remedying these weak areas:

The accounts enabled the nation to locate unused capacity and to exceed by far the production levels that conventional opinion thought possible(20).

But, these authors also make reference to the caution that the 'father' of the National Accounts, Simon Kuznets urged in 1962:

Distinctions must be kept in mind between quantity and quality of growth, between its costs and return, and between the long and the short run ... Goals for 'more' growth should specify growth of what and for what (emphasis added)(21).

Steps have been taken by the major economic institutions including the OECD, World Bank and the IMF to to revise the methodology of national accounting. This relatively recent work suggests the addition of 'satellite' accounts to the main accounts data which would reflect certain components of GDP as costs, eg pollution, congestion and so-on(22). Developing this theme further, Cobb, Halstead and Rowe using data already available, have devised a replacement methodology for US GDP measurement. This is called a 'Genuine Progress Indicator' (GPI): 'The result is a new index that gets much closer - not all the way, but closer - to the economy that people experience(23)'.

The index commences with US GDP consumption data adjusted for income distribution (if the whole population has not benefited from rising production, then this will be reflected in the GPI), and with other activities added, such as the value of housework and community work but with other costs subtracted such as pollution costs. As well, the costs of crime prevention are counted as a plus in traditional GDP accounting whereas most people regard them as cost, so the GPI counts them as a cost. The costs of defending individuals from the degradation of the physical environment are also discounted as well as the costs of resource depletion. Similarly treated is the loss of leisure brought about by people having to work long hours/two jobs.

When the GDP of the United States is correlated to GPI over the post-war period, both indexes move upwards until 1970. From there GPI shows a 45 per cent decline, while GDP continues to rise. (Over the entire period GDP as conventionally measured more than doubles). The authors therefore raise the possibility that the benefits of economic activity since 1970s have actually been outweighed by the costs. They are nevertheless confident that this method better explains people's perceptions of their well being, and for many there is a lack of well being not reflected in the GDP indicators.


The debate on the costs and benefits of downsizing can be seen to add to the demands for reviewing the traditional measures of economic progress. The debate reflects community dissatisfaction with employment and social 'security' - in the broadest sense. Roach's contribution has been to add to a convincing voice to those who hold that deep cuts to corporate staff, functions and products, in the main, contribute to a loss of market share and over the long term limits the potential of the economy to expand - reinforcing the perceptions of employees of their employment insecurity.

A likely response in the particular case of downsizing, may take the form of policies designed to make corporate practices conform to codes or standards. As Kapstein has observed:

The forces acting on today's workers inhere in the structure of today's global economy with its open and increasingly fierce competition on the one hand and fiscally conservative units - states - on the other. Countermeasures, therefore, must also be deep, sustained and widespread. Easing pressures on the 'losers' of the new open economy must now be the focus of economic policy if the process of globalisation is to be sustained (but) the dogma of restrictive fiscal policy is undermining the bargain struck with workers. States are basically telling their workers that they can no longer afford the postwar deal and must minimise their obligations(24).

In an Australian context, the procedures developed for coping with redundancies in the early 1980s indicate a community standard in response to such restructurings. The NSW Government passed legislation to reinforce employers' commitment to job security and in 1982 the NSW Industrial Commission set standards on termination and redundancy pay. These standards were largely maintained in the Termination, Change and Redundancy case of the federal industrial tribunal in 1984, and employers were required to assist redundant employees to find new employment and pay redundancy payments according to years of service, and age, up to a certain level.

The contributions of Roach, Sampson and Burtless assist in explaining an apparent contradiction, observed in industrialised economies, which is the persistence of feelings of insecurity and the 'feel bad factor' among lower and middle income earners, notwithstanding economic data which reports 'growth'. It is thus important to ensure that managers in the private and public sectors are aware that the consequences of downsizing are not necessarily costless for displaced staff and their communities, and that substantial downsizing constrains the option of developing the company's share of market growth and could well be detrimental to those companies.


  1. See for example Restoring Full Employment, a Discussion Paper by the Prime Minister's Committee on Full Employment Opportunities (AGPS 1993) p.51 which sought annual growth rates of 4.5% to reduce Australia's unemployment rate.
  2. See 'The Australian Labour Market - March 1996' in The Australian Bulletin of Labour March 1996 at p.10.
  3. See for example 'Plant Closings: Is the American Industrial Relations System Failing' by K.Kovach and P.Millspaugh in Business Horizons March-April 1987. This article argued that the social and personal disruptions caused by plant closures were so vast that US collective bargaining was not able to handle the consequences making it inevitable that these issues were be referred to the Congress, the courts and the National Labour Relations Board for resolution/assistance.
  4. 'Smaller may not be so beautiful', The Australian Financial Review 10 June 1994. This report referenced a study in the United States of 140 000 factories conducted for the US Census Bureau. It found that 55% of productivity gains came in factories which reduced their workforces, while the other 45% of gains came in factories which increased their workforces (over 10 years). The conclusion was that most corporate downsizings had failed to produce what was expected, and that managers 'would have planned their big moves far more carefully'.
  5. One local example of this consequence was reported in New South Wales in an industrial dispute over redundancy pay for cleaners who were placed in employment with cleaning contractors after the Government Cleaning Service was privatised. The NSW Industrial Commission awarded $25 million to 7 500 workers because they had lost 'secure employment', with the relevant union claiming that the cleaners received inferior entitlements in their new employment, Sydney Morning Herald 30 August 1994; see also the Industry Commission's report No. 28 Competitive Tendering and Contracting by Public Sector Agencies (AGPS January 1996) P.178 & 389.
  6. 'Cuts that work' ABC Television Lateline 13 June 1996.
  7. 'Guru of downsizing admits he got it all wrong', The Independent 12 May 1996.
  8. ibid.
  9. ibid and see also 'On down-sizing and stress - in or out of work', The Canberra Times 19 May 1996.
  10. 'Productivity revisited', The Economist 11 May 1996.
  11. Sampson, A. Company Man The noted British writer responsible for critical works on corporate control and power such as The Sovereign State of ITT, The Seven Sisters and The Arms Bazaar.
  12. An excellent summary of Company Man can be found in 'The downside of downsizing', The Bulletin 23 April 1996 (article by John Connolly)
  13. O'Connor, J. The Fiscal Crisis of the State - St Martins Press 1973.
  14. The Bulletin 23 April 1996.
  15. 'Cut once to keep morale high', The Australian Financial Review 11 June 1996.
  16. See for example 'The capitalism contradiction' by Robert Samuelson Australian Financial Review 17 May 1996 who claims that 'Companies need stable workforces, precisely because excessive turnover raises recruitment and training costs' and that in (the US), 'In 1983, 38% of men over 25 had been with their current company for 10 years or more; by 1991 it was 36%'.
  17. 'Why wages are'nt growing', interview with Gary Burtless in Challenge, November-December 1995.
  18. ibid.
  19. Kapstein, E. 'Workers and the World Economy', Foreign Affairs May/June 1996.
  20. ibid. p.63.
  21. ibid. p.67.
  22. See Parliamentary Research Service: Background Paper 10 of 1994: Greening the National Accounts: Possibilities, problems and Perspectives by Michael Warby.
  23. ibid. p.72.
  24. Kapstein, op.cit. p.17.

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