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The Upside of Downsizing

BY THOMAS K. GROSE

In the late 1980s into the early ’90s, Americans heard a new word to explain why growing legions of them were losing their jobs: “downsizing.” As opposed to old-fashioned layoffs, downsizing’s rationale, we were told, was to transform bloated corporations across the business spectrum into lean, mean, fightin’ machines, ready to take on global competitors. Moreover, downsizing had a technical aspect: A growing reliance on innovations apparently meant that companies needed fewer people to operate efficiently. And it also seemed that, unlike past rounds of layoffs, downsizing was aimed particularly at well-paid, highly educated, white-collar workers—like engineers. Now, however, a recently published book argues that most of the widely held beliefs about downsizing are wrong. Yes, technology and globalization certainly played a role in what we’ve come to call downsizing, but the exercise did not make corporate America any smaller or more productive.

Downsizing in America: Reality, Causes, and Consequences (Russell Sage Foundation; 321 pp.) is the first comprehensive study of the origins of downsizing. Written by New York University economists William J. Baumol and Edward N. Wolf, with Princeton economist Alan S. Blinder, the book is a result of their crunching data from a wide variety of government, business, and academic sources, including a previously untapped and deep well of industrial data, the U.S. Census Bureau’s Enterprise Statistics. They also plowed through nearly 2,000 articles on downsizing culled from the Wall Street Journal and the New York Times from the years 1993-97. Their efforts produced a book that dispels many more beliefs than it upholds.

First of all, downsizing has not been an economywide phenomenon. It’s occurred primarily within the manufacturing sector, which employs only 15 percent of America’s workforce. Indeed, the authors found, within retailing, wholesale trade and other service industries, there’s been job creation, or upsizing, and in other sectors the trend has been mixed. And within manufacturing, downsizing is not something new, either. Many—though not all—U.S. manufacturing industries have been dancing to the steady drumbeat of downsizing since 1967.

And what’s the main cause? Basically it’s this: Downsizing occurs in shrinking industries, which are contracting because of a lack of demand for their products. Moreover, in growing industries, like retailing, upsizing is the norm. That’s a conclusion they admit is “embarrassingly simple,” yet it’s not one they had anticipated. Still, it’s a finding they deem “strong” and “statistically significant.”

But if a lack of demand for an industry’s product is the main reason in the short term for its companies to cut payrolls, it’s not the only determinant. Technology plays a role, too, in the long term, because in dwindling industries it tends to make smaller firms more efficient. Market forces push companies to operate efficiently, which means having an optimally sized workforce, and “technology determines what that efficient size is, and long-run downsizing occurs when technical change requires a reduction in the size of the labor force.”

But Downsizing notes that technology can also force some companies to grow. Innovations tend to require larger firms to cut their workforces, while requiring smaller firms to increase theirs. That’s a phenomenon economists call a regression toward the mean. And, within declining industries, the net result is fewer employees in the long run. There was also evidence that manufacturing industries facing foreign competition are pushed to downsize. And, the book says, there’s a technological edge to that aspect, as well. “Increased globalization is fundamentally rooted in technological advance: Reduced transportation costs, faster telecommunications, and the like are among the primary drivers of increased trade.”

In the retailing and service sectors, growth has resulted in upsizing. And those retailing and service industries that face import competition upsize the most. Interestingly, the book says, industries in those sectors that have lower profitability are also pushed to increase hiring. Technological improvements didn’t have any noticeable effect on upsizing in those sectors.

Adding Jobs

Within manufacturing, however, downsizing is really a misnomer for much of what’s occurred. What’s actually happened, the authors say, is restructuring, or churning. That means that many supposedly downsizing companies weren’t really reducing bloated workforces, but merely reshaping them. Of 133 companies scrutinized by the authors that had announced major downsizings during the period of 1993-97, 55 percent were no smaller in 1998 than they were in 1990, and the majority actually increased their labor forces by more than 10 percent. So much for trimming down to fightin’ shape.

The book offers several rationales for this finding. Some companies downsize as a short-term fix to a cash-flow problem. Some wrongly assume cutting staff will make them more efficient, then have to correct their mistake. And some, because of new technologies, are exchanging unskilled workers for those “better prepared to deal with the requirements of new technology.” Technology may require changing the composition of a workforce, the book says. But it rejects the notion that productivity improvements wrought by technology lead to increasing joblessness. Jobs are lost to technology, yes. But many more jobs are created as a result. Since 1879, they note, U.S. productivity has risen more than elevenfold, yet there has been no long-term upward trend in unemployment.

But downsizing does not bring about increased productivity, the authors determined, despite industry’s claims to the contrary. (Indeed, as noted above, some companies realized they became less productive after they shed employees—perhaps in part because the job cuts damaged the morale and increased the skittishness of the remaining workers.) What companies do get from downsizing is an increase in profits, mainly stemming from the cutting of wages and other employee compensation.

Additionally, downsizing depresses worker remuneration, so downsizing firms do not get more output per labor hour, but do get more output per labor dollar. They pay less for the same amount of work, and that makes it an effective way to hold down wages. “That is the dirty little secret of downsizing,” they claim. And forget about unions acting as a buffer to pink slips; they act more like a magnet. Unionized firms are more likely to trim workers, perhaps because they tend to be higher paid and, ultimately, downsizing is about cutting employee compensation. It’s possible that this new hard-headed attitude of manufacturers toward wages was dictated by efforts to please results-oriented institutional investors. Yet, despite the jump in profits enjoyed by downsizing firms, those companies are not rewarded by Wall Street. In fact, the usual result is a slumping share price. Why? Perhaps, the book suggests, investors view massive job cuts as an omen of “trouble ahead.”

As for downsizing focusing on white-collar workers—didn’t happen. While it’s true, the authors note, that “older, more-educated, white-collar workers have experienced more increases in joblessness . . . less-skilled workers are still bearing the brunt of job loss.” In fact, the percentage of managers in the workforce increases in downsized companies. Moreover, better educated workers are much more likely to find new jobs than those with only high school diplomas. And men and white Americans get re-employed more easily than do women and black Americans. Low-skilled American workers may eventually get back some lost jobs as technologies become more user-friendly and require a less skilled workforce. Then again, they note, as skilled jobs morph into unskilled ones, they often travel offshore to low-wage, underdeveloped countries. Then again, even simpler-to-use machines have complex workings that require specialists to keep them running. Of course, those specialists needn’t be Americans, either. The cycle continues.

The book also disputes the hoary notion that downsizing has transformed a huge segment of well-paid industrial workers into low-paid burger flippers. The authors did uncover evidence that workers changed occupations and industry more often between 1981 and 1992 than during 1969 to 1980, and that more men than women did the changing. And it’s true that most job-changers suffered a loss in earnings. But things have actually improved over time. Workers who changed occupations between 1972 and ’74 suffered an average earnings loss of 13 percent; those who switched jobs between 1990 and ’92 had a loss of just 9 percent. Those who moved to a new industry between 1972 and ’74 had earnings losses of 13 percent; those who moved to a new industry between 1990 and ’92 had no loss in earnings.

The two main mechanisms that trigger either downsizing or churn aren’t likely to disappear. “Consequently, downsizing can be expected to recur repeatedly in the future,” though only for limited periods, the authors predict. Still, they caution against enacting policies designed to limit or stop downsizing because it’s not a long-term threat to employment. Better, they write, to make more effective the familiar solutions designed to give fired workers relief: retraining programs, job counseling and placement services, and income support for workers in transition.

They further argue against Luddite policy efforts to protect jobs from innovation, even though technology can lead to long-term downsizing in shrinking industries. They note that after India gained independence, the government banned computers in the insurance industry to protect the jobs of clerks using pen and ink. Such protections, they write, “contributed little, if anything, to the economy’s total employment, but…go a long way toward explaining the country’s continuing and spectacular poverty.”


Thomas K. Grose is a freelance writer based in Washington, D.C.

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