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The term “downsizing”

The economy was strong, inflation was falling, and real GNP was growing at a steady, confident pace. Corporate profits had reached historically high levels, and investors were on a buying spree in the stock market, pushing it from one record close to the next. Unemployment had fallen to a level that many economists felt was consistent with non-accelerating inflation. Expectations of inflation were abated, and the boom seemed to be poised to last for a long time, with no economic downturn in sight.

At the same time, the major corporations in the US appeared to be firing workers by the undreds of thousands, and job insecurity had risen to a surprisingly high level. Regardless of seniority, the company’s profitability, or the surging demand for the firm’s outputs, the threat to an employee of finding a pink slip in the next pay envelope was real and widespread. No job seemed safe.

The above statements, describing the US economy in the mid 1990s, seem inconsistent not only with a standard textbook characterization of an economic boom, but also with any historically observable relationship between the labor market and other economic arenas, such as the financial market r the goods market. Politicians and unions pointed to the greed of corporate America, and the insensitivity of management to the contributions and value of workers. Standard microeconomics was at a complete loss to explain the phenomenon.

If strong firms were anticipating a greater demand for their products during the economic boom, and labor costs were not rising excessively relative to productivity, why were firms firing workers? The term “downsizing” was coined to describe the action of dismissing a large portion of a firm’s workforce in a very short period of time, particularly when the irm was highly profitable. In a standard downsizing story, a profitable firm well-poised for growth would announce that it was firing a large percentage of its workforce.

The equity market would get excited, and initiate a buying frenzy of the firm’s stock. This goes counter to a standard micro-economic analysis, in which a weak firm anticipates a slump in the demand for its products, and lays off workers, while a strong firm foresees a jump in the demand for its products, and hires more workers to increase production. Investors care about downsizing, since it contains severe implications for the short-term profitability and even the long-term growth of a company.

A downsizing is quite unlike a traditional layoff: in a layoff, a worker is asked to temporarily leave during periods of weak demand, but will be asked back when business picks up. In a downsizing, the separation between a worker and a firm is permanent. A downsizing is also not a dismissal for individual incompetence, but rather a decision on the part of management to reduce the overall work force. Through a downsizing, the management inadvertently (or perhaps deliberately) signals to investors what the future economic health of the firm is.

In the 1980s, the largest layoffs were executed by weak companies, who were losing market share to foreign firms, or had large drops in demand for their products. Downsizings were clearly regrettable, but understandable, as they helped the firms to survive. Such a large amount of workers was certainly unnecessary for a firm doing a smaller volume of sales, so the workers were released in large numbers over short intervals of time. Investors noticed hat major layoffs were taking place, and downgraded their expectations of the firm’s future profitability, so they dumped the stock.

Yet, this perfectly logical explanation seems inconsistent with what was actually taking place in corporate boardrooms and on the trading floors of the New York Stock Exchange of the 1990s: the companies ridding themselves of workers by the thousands were strong, and had bright economic futures ahead of them. Upon learning of downsizings, the alleged signals of firm weakness, investors went on a buying spree, and sent the company’s stock price soaring.

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