Significant Issues Facing Directors - Corporate Responsibility (book chapter) L.

Zeitlin 1

On the Inevitability of Downsizing.

Lawrence R. Zeitlin
Professor Emeritus
Bernard Baruch Graduate School of Business
City University of New York

Cultural anthropologists use a concept called the productivity ratio to estimate the potential for
complexity and sophistication of a society. Broadly defined, the productivity ratio is the number
of people a worker can support at the average standard of living of the culture. The more the
aggregate productivity exceeds the sustenance needs of the population, the greater the likelihood
that the society will engage in such non-material pursuits as art, music, religion, literature,
entertainment, sports, exploration, politics, and education and will develop elaborate social
structures to support these activities.

The productivity ratio has been slowly increasing since the Stone Age. Hunter-gatherer societies,
of which a few remain, have a productivity ratio of 2 or less, requiring most adults to work at
providing food or shelter. The invention of agriculture jumped the productivity ratio to about 3,
permitting the evolution of civilizations complex and sophisticated enough to build the pyramids,
invent politics, found empires, write the plays of Euripides, and do a little mathematics. This
veneer of culture still required that 90% of the population till the fields and build the artifacts. By
the 18th century, the productivity ratio in the Western world had risen to 4, giving rise to most of
the excesses of European history.

Since 1800, following the industrial revolution, the agricultural revolution, and the scientific
revolution, the productivity ratio in developed countries has risen explosively. In the United
States today, one agricultural worker can feed 50 people and one factory worker can supply the
manufactured goods for 14 others. Satisfaction of the material needs of the entire country
requires the efforts of only 8% of the population in fields, factories, and mines. Apart from
certifying that this country possesses an extremely complex and sophisticated society, this
productivity ratio of 12.5 has numerous long term implications for business and for maintenance
of the existing social structure.

For the first time in human history, at least in the developed countries, the supply side of the
Supply-Demand equation is filled. We have the capability of producing more goods with the
available work force than we can reasonably consume. There are two ways to restore balance.
We can increase the demand by advertising, by planned obsolescence, by exporting, and by
absorbing excess productivity in such governmentally supported activities as Social Security, the
space program, Medicare, and military adventurism. Or, we can decrease total productivity by
reducing the number of workers or making their individual efforts less effective. To this extent,
as a society, we have eliminated child labor, extended education, lowered retirement age,
shortened the work day, added vacations, imposed restrictive workplace regulations, enhanced
environmental requirements, and made addition of new workers economically disadvantageous.
In addition we have significantly expanded business functions such as finance, management,
marketing, and human resources not directly involved in material goods production.

Despite our efforts, the productivity ratio is still increasing. Over the last 100 years, the
productivity of the American worker, after allowing for inflation, has increased at a compound
rate of 2.3% per year. An industrial worker today produces nearly 10 times more goods than his
great grandfather did at the turn of the century. In the last three decades, the real productivity
increase has been 2.6% per year and the rate of rise is accelerating. Between 1960 and 1990, the
Significant Issues Facing Directors - Corporate Responsibility (book chapter) L. Zeitlin 2

share of inflation adjusted GDP per worker, averaged across the US economy, increased
sevenfold. Part of this increase in productivity was due to the labor multiplying effect of
technology and part to the better selection, training, and management of workers. The most
substantial portion was due to the decreasing use of human labor in the manufacturing process.

Examples of this dramatic increase in productivity are easy to find. In 1900 the labor component
of manufacturing averaged 85%, by 1990 it was down to 60%. Today, in some portions of the
electronic industry and petrochemical industry it is less than 1%! The production manager’s
ideal of a fully automated factory, exempt from labor concerns, union demands, and OSHA
regulations is imminent.

The automobile industry and its related suppliers represents a significant portion of the material
goods economy of the industrial world. In 1986, automobile assembly plants in both Japan and
the United States averaged approximately 30 cars per worker per year. In 1996, modern
assembly plants in both countries average approximately 100 cars per worker per year. This
represents a compound increase in productivity of nearly 13% per year due largely to redesign of
vehicles so that less human work is required in construction. Since automobile demand had not
tripled during this decade, the impact on labor could be easily predicted. In 1995, General
Motors announced layoffs of 74,000 workers and the closing of several plants. Japanese
automobile companies abrogated their implicit bargain of lifetime employment and shut down a
number of assembly lines. The focus of UAW agreements with Ford and Chrysler was on job
preservation and the rallying cry in the ongoing UAW battle with General Motors is “job
ownership”.

Even essentially service industries experience productivity pressure on employment. In recent

years, the U. S. Merchant Marine has been decimated. Larger and faster ships equipped with
sophisticated systems required smaller crew sizes. High wages and restrictive work rules made it
advantageous for shippers to establish offshore fleets sailing under flags of convenience. As a
consequence, the number of U. S. seagoing jobs has declined by nearly three quarters, from
nearly 70,000 jobs in the early '60s to fewer than 18,000 jobs at present.

Business finds itself in an unusual dilemma. The elasticity of the demand side of the equation is
decreasing. Transferring productive efficiencies to lower market prices no longer increases
demand and consumption the way it did in the past. With demand essentially limited, the only
way to satisfy the need for the increasing profits required by the financial community is to cut
overall costs. The most effective way to do that is to take advantage of the inevitable rise in
productivity by further decreasing the labor component of manufactured goods. A brief
numerical exercise will show why this is the short term solution many companies have adopted.

Because labor costs are the dominant cost of doing business in all but a few endeavors,
decreasing overall labor costs may be the single most beneficial step taken by management in
increasing profitability or organizational effectiveness. For most jobs, the variation in individual
work productivity is likely to be greater than the range in compensation. This situation occurs
where worker output can vary (sales, management, non-production line factory work, skilled
labor, professions, etc.) but employment costs (benefits, overhead, investment, etc.) are relatively
fixed. By suitably pruning the work force, retaining the most effective workers, it is possible to
maintain or even increase overall output or work quality without incurring corresponding
increases in cost.

Example: The GDP of the U.S. in 1994 was approximately $6.727 trillion dollars, produced by
the efforts of approximately 117 million full time equivalent workers. Each worker’s share of the
Significant Issues Facing Directors - Corporate Responsibility (book chapter) L. Zeitlin 3

GDP was $57,234. Considering only the commercial sector, the average labor component of
productive output is 60% or $34,340 per worker. Costs of materials and other costs of doing
business (advertising, distribution, administration, etc.) are another 30%, leaving only 10% or
$5,723 per FTE worker for gross profit. If the labor component efficiency can be increased by
10% by selective downsizing and output maintained by appropriate worker management,
selection, training, and work design, all other costs remaining constant, profit increases by
$3,434 or 60%.

No wonder downsizing is so attractive. In what other way can a CEO nearly double profits by the
stroke of a pen. At a first approximation, each 1% reduction in work force costs results in a 6%
increase in profitability. What is implied in this analysis is that there is a transfer from labor cost
to profit. Such a transfer can only be achieved if output and sales are maintained at the pre-
downsizing level and other costs remain unaltered.

Downsizing is inevitable. A capitialistic society cannot require business to commit economic

suicide by maintaining a less than competitively productive work force. Nevertheless, while
economically attractive in the short term, downsizing across the board cannot be tolerated for an
extended period for a whole society. As productive jobs are eliminated, the social fabric of a
culture that measures human worth by occupational status deteriorates. The suggestion that
“elimination of welfare as we know it” will encourage welfare recipients to enter the work force
assumes that jobs are available for poorly skilled marginal workers. In fact the very existence of
the welfare population is the result of previous downsizings in the segments of the economy
which employed large numbers of agricultural and unskilled workers. Similarly improbable is
the hope that increased productivity will revitalize American industry to the point that it will
again be in a position to supply the world’s need for material goods. Knowledge of the
technology responsible for high productivity is widespread. Third World managers capable of
utilizing this technology are being educated today in our business schools and technical
institutes. The rest of the world will soon be in a position to supply itself and export the surplus
to our shores.

Massive changes in the size, structure, organization, and composition of the work force are not
new. They occur in response to most major political, economic, and technological forces.
Downsizing is driven by economic, technological, and political pressures which impact both the
organization and the individual. Multinational corporations aided by a free trade policy have
transferred labor intensive manufacturing jobs to low labor cost areas. Technological changes in
the workplace have obsoleted many skills and have forced the redefinition, consolidation, or
elimination of many positions. Political forces impose regulatory burdens on the manufacturing
sector which encourage reduction of domestic employment in favor of offshore production
and/or automation.

Current concerns about downsizing are due more to the positions of persons affected than to their
number. This work life disruption differs from those that preceded it in that its impact is most
profound on those employed in the middle levels of the organizational structure and who are able
to take their collective anxiety public. IBM, for example, has reduced its work force from
400,000 to 200,000 over the last five years. Over 85% of the persons terminated or retired were
above the entry level. General Electric has downsized by one third, primarily through forced
early retirement of mid-level positions. The military, in cutting its manpower by 60% from the
height of the Reagan/Bush era, has taken the unprecedented step of reducing its officer
compliment by a greater percentage than its enlisted compliment. Even government is not
exempt. Both parties claim a popular mandate to downsize the bureaucracy at all levels.
Significant Issues Facing Directors - Corporate Responsibility (book chapter) L. Zeitlin 4

Still, short of a revolutionary change in the distribution of goods and income, every downsized
worker must be able to find another position. Since the manufacturing sector is saturated, jobs
must be developed in service industries and in the public sector where the productivity multiplier
of technology is not as profound. Most of the jobs created during the 90’s are in the service
sector. The joint governmental demands that productivity be raised while simultaneously
encouraging the private sector to increase employment are mutually incompatible. Given the fact
that national demand for material goods is limited and that worldwide competition sets
constraints on exports, increasing the productivity of the individual worker through education
and training will inevitably lessen employment opportunities, particularly for those individuals
less able to profit from education. As technology proliferates in the workplace, the less
technologically adept will find it increasingly difficult to gain employment. To ameliorate this
problem, the government should, of necessity become an employer of last resort, using surplus
productivity to rebuild the nation’s ailing infrastructure.

Finally, there is a silver lining to the problem of productivity increase. Politicians point with
alarm to the spectre of Baby Boom retirees bankrupting the Social Security system. At present
there are 4.8 workers supporting each retiree. By the year 2020, there will only be 2.5 workers
per retiree. To maintain each retiree in 1996 splendor will require an increase in Social Security
taxes appropriate to an inflation adjusted per worker share of the GDP of $96,000. To reach this
figure requires a compounded annual increase in worker productivity of 1.7%. However we have
already shown that the increase in real productivity is approximately 2.6% per year and, if the
trend continues, the GDP per worker by 2020 will be $124,000. The sanguine conclusion: in the
long run Social Security is solvent, Medicare will be paid for, and downsized workers will have
jobs. Time heals all wounds.