Effect of Downsizing on Manufacturing Industries

¶ … downsizing on Manufacturing Industries

The amount of information on the effects of down sizing on manufacturing was not plentiful, however one main point that flows through all of the articles is that even though down sizing may be done to help a company it can end up hurting them in the long run. In the paragraphs to follow we look at the effects that downsizing has on people and companies as well as look at whether or not downsizing is truly the answer.

Parker (2003)Reports that in 2003 the expected job losses among the manufacturing industries in Great Britain would create the effects of rising input costs and oil price increase on the job cuts; Downturn of the purchasing managers' index for manufacturing; Decrease in the rate of manufacturer's orders. So even though these cuts may be necessary he pointed out that it would have an overall negative effect.

The Midwest may be the focus of manufacturing layoffs and financial woes (Link, 2005), but according to this survey, people who live in the area of the country that includes Cleveland and Detroit in the low- to moderate-income lax bracket are using less of their income to pay for housing than other areas of the country. The study, dubbed the Housing Landscape for America's working Families 2005, revealed that from 1997 to 2003 the number of America's working class who spend more than half of their income on housing leaped from 2.4 million to 4.2 million. The study also revealed that immigrant families are 75% more likely to use more of their income to pay for housing than American-born citizens. Across the country there are 14 million people that spend too much of their income 10 pay for housing. About 35% of that group is low- to moderate-income families.

In 2003, the critical housing need for the Midwest totaled 8.7% of residents while the West Coast had a need among I6.89 (of its residents. The South followed the Midwest for a lower critical housing need with 9.3% while the Northeast trailed California with a need among 14.2% of its residents (Link, 2005).

(Palley, 1999) Reported that given the dismal economic performance that marked the period from 1990 to 1995, when downsizing was widespread, inequality widened, and real wages fell, the subsequent U-turn in performance has been completely unexpected. Moreover, it has been cause for further surprise that the economy has continued to prosper despite the East Asian financial crisis, which destabilized global financial markets, undermined U.S. exports, and unleashed a surge in U.S. imports.

A second source of uncertainty (Palley, 1999) concerns the sustainability of the growth of personal consumption spending, which had been the principal engine of economic expansion in the past two years. In 1997, personal consumption expenditure contributed 59% of gross domestic product (GDP) growth, and in 1998 it contributed 85%. Meanwhile, in 1997 and 1998 nominal personal consumption expenditures grew 5.3% and 5.7%, respectively, while nominal disposable income grew only 4.7% and 4.0%. From the Federal Reserve's perspective, this pattern is not sustainable since consumption is growing faster than potential output, which implies that the economy will eventually hit an inflationary wall. An alternative interpretation is that such growth is not sustainable because households must inevitably run short of financial wherewithal, and when this happens, an economic decline will ensue. According to this view, recession rather than inflation is the danger.

A last scenario concerns the possibility of a full-scale crash or economic depression. Such an outcome is the least likely of the three scenarios, but it is still more likely than it used to be. In the 1960s and 1970s, the possibility of an economic depression was truly far removed. However, in the 1990s such a notion has surfaced as plausible, even if unlikely. Recent events in the global economy have added further credibility to this possibility.

One reason a crash has become more likely is that many of the factors precipitating a hard landing are already in place, which means that many of them could be realized simultaneously. Indeed, many of these factors are linked in trip-wire fashion so that if one occurs, it triggers another. Thus a Federal Reserve-induced increase in interest rates could trigger a stock market crash, and this could then trigger an end to the spending boom. It could also trigger renewal of global financial instability.

Similarly, a renewal of global financial instability could become the event that bursts the stock market bubble. Alternatively, a realization that the existing U.S. current-account trajectory is unsustainable could trigger a foreign exchange crisis that would renew global financial market instability, trigger a stock market crash, or evoke a Federal Reserve rate hike to protect the exchange rate and guard against imported inflation.

Finally, if the economic expansion begins to flag of old age, overoptimistic projections of corporate profitability could pop, triggering a stock market crash. Also, a flagging economy could renew global financial turmoil by ending the U.S. economy's role as buyer of last resort, thereby undermining the rest of the world's economic recovery, which rests significantly on export-led growth.

However, it is not just this interconnectedness of negative factors that lies behind the increased plausibility of a crash. A second and more important factor concerns changes in the structure of the domestic and global economy that have diminished the presence of "automatic stabilizers" and replaced them with "automatic destabilizers."These destabilizers work in a pro-cyclical fashion. On the cyclical upswing they make for stronger and longer expansions, but on the downswing they make for deeper and more sustained contractions.

One important change concerns patterns of employment and remuneration. In earlier business cycles, labor hoarding was a common practice -- firms held on to workers through downturns in order to retain their skills and avoid future hiring costs. However, the changed pattern of the employment relationship means that firms now hire and fire much more freely, making labor incomes more pro-cyclical. It is also the case, especially in manufacturing, that overtime has become more important as firms have sought to save on employment costs by extending hours rather than hiring new personnel. Wage income is therefore more vulnerable to downturns since hours can quickly be cut back in a downturn. Finally, casual evidence suggests that there may have been an increase in the use of incentive pay, with greater reliance on stock options and profit-related bonuses. In a downturn these forms of pay are likely to fall off rapidly, contributing to a larger decline in household income and spending. In sum, the above labor market developments all make wage income more procyclical, thereby increasing the pro-cyclicality of demand (Palley, 1999).

Another development concerns the general flexibility of wages. In the period from 1950 to 1980, recessions were characterized by a decline in the rate of increase in nominal wages. However, the important point is that wages still rose in recession. The recessions of 1981-1982 and 1990-1991 suggest that a new pattern may have emerged. Now not only does the rate of wage inflation slow, but nominal wages can fall. This is a very important development when it is considered in conjunction with the new debt-driven business cycle. The ability to repay consumer debt depends on the nominal value of income. In a recession the value of debts remains unchanged, but now wage incomes may show a tendency to fall. This will tend to increase debt burdens and raise the prevalence of bankruptcy, thereby deepening recessions.

Just as developments in labor markets have contributed to the emergence of automatic destabilizers, so have developments in financial markets. Households now have significantly increased access to credit. In particular, households are able to borrow more heavily against their assets, thereby increasing their ratio of debt to income. Home equity loans are the most prominent example. Another is the ability to borrow on margin against stock holdings. These innovations and their spread give the economy a strong pro-cyclical impulse, but they also generate greater financial fragility. Thus, in upswings when asset prices and wages are rising, households borrow more and spend more, thereby lengthening the cycle. However, when the downswing occurs, households are now saddled with greater indebtedness and may also be subject to margin calls. This worsens the downturn and may contribute to even greater stock market corrections (Palley, 1999).

The shift from defined benefit to defined contribution pension plans is another automatic destabilize. First, households are able to borrow against these contributions. Second, these plans may change household consumption and saving behavior since each month they receive statements showing how the value of their pension holdings has increased. Thus, as stock market prices rise, households cut back on saving and increase consumption, while some households borrow against their appreciated 401(k) accounts. However, stock prices are likely to fall in a recession, while the incurred debts will remain unchanged. At that time, households will have larger debts and reduced holdings of liquid assets.

Finally, it is worth noting that prices in the stock market may have been at bubble levels for more than three years; recall that Chairman Greenspan gave his "irrational exuberance" warning back in 1996. This means that a considerable amount of borrowing and spending has taken place on the basis of these bubble prices, so the bubble may be deeply embedded in the balance sheets of agents. This means that a market correction is likely to be all the more severe. In effect, the size of the negative impact of an asset price bubble is positively related to the duration of the price bubble.

Accompanying these changes in the domestic economy have been changes in the global economy that have contributed to the emergence of international automatic destabilizes. One change is the increased degree of international financial capital mobility. When a country's financial markets begin to fall, it is easier for asset holders to exit, thereby creating a larger stampede for the exit. Foreign holders have an incentive to exit to protect the domestic-currency value of their holdings, and they now have a larger impact because of their increased holdings. Domestic holders are also more likely to exit because of reduced transaction costs and the increased sophistication of financial markets. They recognize that exit is the way to maximize the dollar value of portfolios when the dollar is under pressure.

A second development is the increased international integration of goods markets. In theoretical terms, the foreign trade expenditure multiplier has become larger, which means that economic activity across countries has become more connected, making for greater amplitude in the world business cycle. In the 1950s and 1960s it was said that when the U.S. economy sneezes, the world economy catches a cold. Globalization of goods markets may have created a situation in which the U.S. economy sneezes and the world economy catches pneumonia.

In this study (Wertheim, 2004), has developed a hypothesis which combines the effects of both economic impact and pre-disclosure information with the financial distress and potential benefit hypotheses developed in prior research in corporate downsizing. Instead of offering that these two hypotheses as competing and mutually exclusive, evidence are provided that supports the conclusion that these hypotheses simultaneously explain concurrent and additive effects on the stock price reaction to announcements of company layoffs. Finally, results indicate that the relationship between economic impact, pre-disclosure information and stock price reaction to layoff announcements depends on the relative dominance of the signals provided by the layoff about both financial distress and potential benefit.

(Palley, 1999)stated that for policymakers at the Federal Reserve, the goal is a soft landing, though some (those who continue to believe in the natural rate of unemployment) think a bumpy landing is desirable since they believe that the unemployment rate is now below the natural rate. Thus not only is the economy expanding more rapidly than potential output, but the level of output already exceeds the level of potential output. Consequently, not only must the rate of output growth decrease, but the rate of unemployment must also rise back to the natural rate in order to avoid accelerating inflation.

Since around 1980, there has been a determined drive to downsize American organizations (Budros, 1999) and there currently is no end in sight to this movement, even though studies underscore its technical-economic and human dysfunctions. This situation indicates a need to consider why organizations downsize in the first place, yet the shortcomings of the scholarly literature on this issue are conspicuous (Budros 1997). Therefore, in that paper he offered some systematic thoughts on the causes of downsizing. He developed a conceptual framework for exploring organizational innovation that features two under explored dimensions associated with this phenomenon, the basis of organizational action (rational vs. irrational) and social context (organizational vs. extra-organizational). He then portrayed downsizing as an organizational innovation and identified factors that lead organizations to downsize.

(Palley, 1999) suggests that there are three possible future paths -- a soft landing, a hard landing, and a crash. A soft or hard landing is by far the more likely outcome, but, that said, it is possible to imagine conditions in which a crash will occur. Japan's prolonged hard landing, East Asia's economic crisis, and the October 1998 near-meltdown of global financial markets have all added plausibility to such an outcome.

A soft landing has the rate of output growth gradually slow to a level consistent with potential output growth. According to current consensus thinking, this potential rate of growth is somewhere between 2 and 2.5%, though New Economy optimists claim it to be as high as 3%. A bumpier version of the soft landing (a.k.a. growth recession) has the rate of output growth slowing below potential but growth still remaining positive. Under this scenario, unemployment rises but the economy avoids a formal recession since output continues to grow. A hard landing has the decline in output growth such that it turns negative so that the economy is pushed into recession and unemployment rises even more. Finally, a crash involves a collapse in the rate of output growth, so that the economy enters a deep recession that may even border on a depression (Palley, 1999).

The use of an organizational innovation framework to examine downsizing clearly has shed light on this phenomenon (Budros, 1999), revealing that organizations may make people cuts in response to rational organizational, rational extra organizational, irrational organizational, and irrational extra organizational processes. Of particular interest is the realization that scholars have focused almost exclusively on rational (organizational and extra-organizational) causes of downsizing, neglecting the role irrational forces may play in workforce reductions. Perhaps this situation prevails because of the longstanding inclination among scholars to view organizations as efficiency-minded social actors. But if we are to develop a complete understanding of downsizing, then we must evaluate the impact of rational and irrational factors on this practice.

This research investigates organizational practices in downsizing after a restructure and the effects of these practices on an organization and its employees (Labib, 1993), in particular, and on other stakeholders in general. Findings indicated that it is not downsizing that causes negative effects on both terminated and surviving employees, but rather the human resources practices used to implement downsizing; such as advance notification, method of termination, and amount and type of post-termination assistance given. This research further found that organizations often do not achieve their strategic goals after downsizing because they do not adjust their work processes and their human resource management practices to the new size and structure of the organization. Based on the literature review, a process model for the development and implementation of downsizing plans is proposed. The model is designed to provide a guide to be used by organizations when downsizing to ensure that the interests of all stakeholders are taken into account. The proposed model is tested through a field research in the form of case studies of five major organizations in Canada. The actual practices of these organizations are outlined and compared to the proposed process model, both collectively and individually. The differences are then analyzed and a new revised model is proposed that emphasizes, not only the downsizing process itself, but also what organizations must do during and after downsizing to ensure that employees' needs are met and that the new strategic goals that prompted the downsizing are achieved. Two conclusions are drawn from this research. The first is that downsizing, if it is necessary, must be undertaken in a way that would cause the least amount of pain to those affected which is the ethical responsibility of good corporate citizenship. The second conclusion is that downsizing, in itself, is not enough to ensure increased profitability and goal attainment, but rather, it is how the organization functions afterward that will indicate whether or not the downsizing was a good or bad thing (Labib).

The topic of off shoring generates extreme differences of opinion among policy makers, business executives, and thought leaders. Some have argued that nearly all service jobs will eventually move from developed economies to low-wage ones. Others say that rising wages in cities such as Bangalore and Prague indicate that the supply of offshore talent is already running thin.

To a large extent, these disagreements reflect the confusion surrounding the newly integrating and still inefficient global labor market. Much as technology change is making it possible to integrate global capital markets into a single market for savings and investment, so digital communications are giving rise to what is, in effect, a single global market for those jobs that can now, thanks to IT, be performed remotely from customers and colleagues.

The newly integrating nature of this global labor market has strategic and tactical implications for companies and countries alike. Information and insight about it are sparse, however, and executives and policy makers have little of either for making the decisions they face. To provide help for governments and companies in both high- and low-wage economies, the McKinsey Global Institute (MGI) analyzed the potential availability of offshore talent in 2.8 low-wage nations and the likely demand for it in service jobs across eight of the developed world's sectors (chosen as a representative cross-section of the global economy): automotive (service jobs only), financial services, health care, insurance, IT services, packaged software, pharmaceuticals (service jobs only), and retailing. These sectors provide about 23% of the nonagricultural jobs in developed countries. The study, which projects trends to 2008, aims to assess the dynamics of supply and demand for offshore service talent at the occupational, sectoral, and global level and thus the likely impact on both employment and wages in the years ahead.

MGI's analysis provides a panoramic view of the off shoring of services, as well as a number of useful conclusions, including:

Off shoring will probably continue to create a relatively small global labor market -- one that threatens no sudden discontinuities in overall levels of employment and wages in developed countries.

Demand for offshore labor by companies in the developed world will increasingly push up wage rates for some occupations in low-wage countries, but not as high as current wage levels for those occupations in developed ones.

Potential global supply and likely demand for offshore talent are matched inefficiently, with demand outstripping supply in some locations and supply outstripping demand in others.

The more efficiently the emerging global labor market functions, of course, the more value it will create for its participants by allocating resources more economically. Both companies and countries can take specific measures to raise its efficiency in clearing demand and supply.

Broadly speaking, a suitably qualified person anywhere in the world could undertake any task that requires neither substantial local knowledge nor physical or complex interaction between an employee and customers or colleagues. Using these criteria, we estimate that 11% of service jobs around the world could be carried out remotely.

Of course, some sectors provide an unusually large number of such jobs. As a rule, industries with more customer-facing functions have less potential in this respect. Consequently, the retailing sector, in which the vast majority of employees work in stores, could offshore only 3% of its jobs by 2008. Yet because retailing is such a huge employer around the world, this would be equivalent to 4,900,000 positions. In contrast, by 2008 it will be possible to undertake remotely almost half of all jobs in the packaged-software industry, but in this far less labor-intensive business, that represents only 340,000 positions.

Some occupations also are more amenable than others to remote employment. The most amenable to it are engineering, on the one hand, and finance and accounting, on the other (52% and 31%, respectively). The work of generalist and support staff is much less amenable (9% and 3%, respectively), because those workers interact with their customers or colleagues extensively. But generalists and support workers permeate every industry and therefore provide the highest absolute number of jobs that remote talent could fill: a total of 26,000,000.

In practice, just a small fraction of the jobs that could go offshore actually will. Today, around 565,000 service jobs in the eight sectors we evaluated have been off shored to low-wage countries. By 2008, that number will grow to 1,200,000. Extrapolating these numbers to the entire global economy, we estimate that total offshore employment will grow from 1,500,000 jobs in 2003 to 4,100,000 in 2008 -- just 1% of the total number of service jobs in developed countries. To put this number in perspective (in what is, to be sure, not a direct comparison), consider the fact that an average of 4,600,000 people in the United States started work with new employers every month in the year ending March 2005.

Why is the gap between the potential and actual number of jobs moving offshore so large? Many observers think that regulatory barriers stand in the way, but MGI interviews indicate that company-specific considerations (such as management attitudes, organizational structure, and scale) are generally more powerful deterrents. Companies cite cost pressures as the main incentive to hire offshore labor, for example, but the strength of cost pressures varies by sector. Many companies lack sufficient scale to justify the costs of off shoring. Others find that the functions they could offshore in theory must actually stay where they are because their internal processes are so complex. Often, managers are wary of overseeing units on the other side of the world or unwilling to take on the burden of extra travel.

On the supply side, developing countries produce far fewer graduates suitable for employment by multinational companies than the raw numbers might suggest. Nonetheless, the potential supply of appropriate workers is large and growing fast, and some small countries boast surprisingly large numbers of them.

The 28 low-wage countries we studied have some 33 million young professionals: university graduates with up to seven years of work experience. The eight higher-wage nations in our study have 15 million -- 7.7 million in the United States alone.

Yet interviews with 83 human-resources managers for multinationals operating in low-wage economies indicate that, on average, only 13% of the university graduates from the 28 low-wage nations are suitable for jobs in these companies (Exhibit 1). The HR managers give a variety of reasons for the problem, especially a lack of language skills, an emphasis on theory at the expense of practical knowledge, and a lack of cultural fit (meaning interpersonal skills, as well as attitudes toward teamwork and flexible work, that are at odds with the norm in multinationals).

The proportion of suitable job candidates varies by occupation and, even more, by country. So while 50% of the engineers in Hungary or Poland, for example, could work for multinational companies, only 10% and 25% of those in China and India, respectively, could do so. In general, university graduates from Central European countries are well suited to work for multinationals. By contrast, job candidates from Russia are well educated but often by universities that fail to give them practical skills, while in India the quality of the educational system -- top universities apart -- handicaps graduates. A lack of strong English language skills is the most pressing issue for Brazil and China.

In large emerging markets, the pool of suitable talent shrinks further because many university graduates live far from major cities with international airline connections (twin criteria for multinational companies seeking offshore locations) and would rather stay close to home. Only one-third of Russian graduates live in major cities, and few of the others are willing to move. By contrast, nearly half of all Indian students graduate from universities close to major international hubs (such as Bangalore, Delhi, Hyderabad, and Mumbai), and Indians are also the most willing to relocate. In China, multinationals face an additional problem: strong competition from companies serving the domestic market.

These "pool-shrinking" factors mean that of the 33 million potential young professionals in the low-wage markets we studied, only about 3.9 million -- 12% -- are both suitable for multinationals and realistically available for hire. In our sample of high-wage countries, by contrast, 8.8 million young professionals meet both conditions (Exhibit 2). But 3.9 million is still a deep pool. In some occupations, such as engineering, finance and accounting, and quantitative analysis, that number represents 75% or more of the suitable labor in our sample of high-wage countries.

Moreover, the amount of suitable labor in low-wage countries is growing fast. Their university graduates are increasing in number at a yearly rate of 5.5%, as compared with just 1% in developed countries. The growth in the ranks of people with qualifications that multinationals actually want is particularly rapid: in just five years, the proportion of degrees awarded in business and economics has jumped to 31% of the total, from 18%, in Russia and to 36%, from 16%, in Poland. What's more, by 2008 the supply of suitable young engineers is likely to be almost the same in the developing and developed countries we studied, and suitable finance and accounting professionals from the developing countries will outnumber those from the high-wage ones.

A country's supply of suitable talent, as opposed to its overall number of university graduates, isn't proportional to the size of its population: though China's population is 16 times bigger than that of the Philippines, for instance, its pool of suitable young English-speaking engineers is only 3 times as big. Poland has nearly as many suitable engineers as does much more populous Russia. The Czech Republic, Hungary, Poland, and Russia together have as many suitable generalists as does India, which has 5 times their total population, and nearly as many suitable engineers. As a result, many countries besides China and India could play roles in the emerging global labor market.

In aggregate, the potential supply of offshore talent suitable for employment by multinationals exceeds likely demand in each of the eight occupations they analyzed. In 1008, for instance, the potential supply of support staff and of young professional generalists suitable for employment by multinational companies will exceed likely demand by 98% and 78%, respectively. Only the potential supply of engineers from low-wage countries looks a little tight at the global level (Robert, 1996).

But the aggregate view creates an illusion of abundance. In fact, companies that hire offshore talent tend to follow one another to locations with a track record of providing it instead of choosing places that meet each and every need. The concentration of companies does have some positive effects, such as speeding improvements in infrastructure, communications, and the business environment. But eventually that approach can create local imbalances between demand and supply, and these imbalances in turn produce local wage inflation and high levels of attrition among workers.

This kind of concentration is already affecting the supply and cost of labor in some cities in the Czech Republic, India, and Russia. If current demand trends continue, the supply of suitable labor will be squeezed in Prague as early as 2006 and in Hyderabad by 2008, thereby making those cities less attractive for the many companies whose sunk costs in physical and human capital there will make it hard for them to switch locations. If companies were to disperse their demand more widely, overall wage levels for offshore labor would rise more slowly (see sidebar, "What off shoring may do to wages," on the next page).

Data about the effects of off shoring on wages are scarce in both the demand- and the supply-side countries. Yet we gained insight into these effects by modeling the outcomes of a variety of hypothetical corporate decisions.

What, for instance, would be the effect on the wages of engineers in emerging markets if labor costs were the most important factor for U.S. companies choosing offshore locations? Our analysis shows that salary levels for engineers in the lowest-cost countries would likely double (exhibit). But salaries in emerging markets wouldn't reach the prevailing level in the United States or Western Europe, since they will be capped at about 30% of average U.S. wages, or the current level in Brazil and Mexico (Robert, 1996).

Local wage inflation will probably continue in some off shoring locations as long as the multinationals concentrate their demand in a few cities. Because of the sunk costs of setting up an offshore facility, if demand in that location begins to outstrip local supply, the wages paid by individual companies may rise above the levels prevailing in neighboring countries. Dispersing demand will slow down overheating in the hot spots.

Overall, although wages in the supply-side countries will probably rise, they won't reach the level of wages in the demand-side countries.

Companies are moving their operations offshore at a slow pace, which means that over the next five years off shoring, will have a negligible effect on overall employment in the demand-side countries for the occupations we analyzed.