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Why Corporate Downsizing Doesn't Work: The 'Confessions' of Stephen
Roach and other Views
Stephen O'Neill
Economics, Commerce and Industrial Relations Group
Contents
Introduction
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
Conclusion
Endnotes
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.
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).
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.
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).
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 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).
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.
- 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.
- See 'The Australian Labour Market - March 1996' in The Australian
Bulletin of Labour March 1996 at p.10.
- 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.
- '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'.
- 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.
- 'Cuts that work' ABC Television Lateline 13 June 1996.
- 'Guru of downsizing admits he got it all wrong', The Independent
12 May 1996.
- ibid.
- ibid and see also 'On down-sizing and stress - in or out of
work', The Canberra Times 19 May 1996.
- 'Productivity revisited', The Economist 11 May 1996.
- 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.
- An excellent summary of Company Man can be found in 'The downside
of downsizing', The Bulletin 23 April 1996 (article by John Connolly)
- O'Connor, J. The Fiscal Crisis of the State - St Martins Press
1973.
- The Bulletin 23 April 1996.
- 'Cut once to keep morale high', The Australian Financial Review
11 June 1996.
- 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%'.
- 'Why wages are'nt growing', interview with Gary Burtless in Challenge,
November-December 1995.
- ibid.
- Kapstein, E. 'Workers and the World Economy', Foreign Affairs
May/June 1996.
- ibid. p.63.
- ibid. p.67.
- See Parliamentary Research Service: Background Paper 10 of 1994:
Greening the National Accounts: Possibilities, problems and Perspectives
by Michael Warby.
- ibid. p.72.
- Kapstein, op.cit. p.17.
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