Tuesday, August 11, 2009

Productivity and Layoffs

The good news: productivity jumped up in the second quarter, according to the U.S. Department of Labor. The bad news: The improvement in productivity is almost entirely the result of layoffs, facility closings, and bankruptcies — and that trend is sure to continue.

This is the way economic theory says it should go. Imagine that you have two companies, one of which is more productive than the other. The more productive company will tend to be more profitable because its costs are lower; in times like these, that could mean it is breaking even while the less productive company is losing money rapidly. If the less productive company shuts down, the result is an increase in the average productivity.

It works essentially the same way when companies choose which of their factories, stores, and other facilities to close when they have to cut back, and also when they shut down departments and product lines that don’t add much to the company’s operations.

Despite the theory, usually in a recession we see productivity decline. Companies find themselves with excess capacity, too many workers for the work they have to do, but they are reluctant to cut back for a downturn that may last less than a year. This recession is different. Companies are forced to cut back at least enough to break even.

A business cannot simply borrow a few billion dollars this year the way it could in any of the last ten recessions. Banks and business lenders are trying not to make any loans to companies in trouble. If a business does take out that kind of loan this year, often it is just a first step toward bankruptcy.

We see that, most notably, at CIT, which warned this morning that it faces the possibility of bankruptcy as early as August 17 (though Forbes thinks a November bankruptcy is more likely). CIT used to be the go-to business lender until the credit markets turned on it early this year. Now it serves mainly as a cautionary example of how quickly a business can go from profitable to helpless when it loses control of its cash flow.

The business credit market is not improving; it is getting worse and shows no sign of turning the corner this year or next. Businesses still have to cut back as much as it takes to pay their bills. The productivity report shows that businesses have made themselves more profitable by laying people off and closing facilities, and they will do it again as soon as they need to. As unfortunate as it is for the workers who lose their jobs, businesses this year have few other options.