May 26, 2005

The “flexible” American Labor Market.  One of the great things about economic analysis is that things are constantly changing.  What once was a “given” is now an “old way of thinking.”  Look something like management practices toward labor issues.  Back in the 1980’s the business press was all aglow over the “Japanese management-style.”  Stories abounded on topics such as life time employment, flexible teams, cooperation between competitors, etc.  

Oh, how things have changed!  Now the business press is full of stories on how downsizing is efficient, the need to be able to lay-off workers is a “must” in the modern economy, etc.  This “American model” in now the rage throughout the world. 

But as is often the case the “hot” concepts currently in vogue with the business press require further economic analysis to see if they are all so wonderful.  As we learned with the collapse of the Japanese asset bubble in the late 1980’s the Japanese model was not perfect.  There were some positive attributes to it, but there were also some huge flaws.  The same thing, no doubt, will come to pass with the current cost-minimization “American model.”

Recently the Federal Reserve Bank of Chicago held a conference that looked into the changing aspects of the American labor market.  In one of the papers presented, Peter Cappelli from Wharton, showed how the changing nature of “lay-offs” has triggered changes in our labor markets.  Unfortunately many managers are not fully aware of what these changes mean.

Cappelli correctly points out that during the 1970’s and 1980’s lay-offs were used as a way to react to temporary weakness in markets.  Firms would lay-off workers during slow periods with the intention of recalling these workers when market conditions improved.  But during the 1990’s the nature of “lay-offs” in America changed.  With downsizing and rightsizing “lay-offs” now became permanent.  Thus the lay-offs were no longer intended to reduce output they were now intended to increase earnings while output levels were often expected to remain the same or even increase.

Cappelli argues that since lay-offs are no longer based on seniority and are not triggered purely by business cycle fluctuations, those that are subject to lay-offs are no longer only young, unskilled workers.  Lay-offs now can run up and down the seniority and skill ladder.

However, when firms do need to hire additional workers, due in business cycle upswings and/or expansion into new product lines, firms most often want to hire experienced workers.  When doing so, they will often look to workers at competing firms.   Cappelli points out that the biggest source is new hires are other employers.  

Thus, what happens is when the economy picks up those workers who have survived the lay-offs at their firms are quick to “jump ship” when the competition “comes knocking.”  Evidence suggests that employees see this as a way of “punishing” their current firms for the firms past behavior.

Increased voluntary turnover thus is thus a by product of lay-off driven, involuntary turnover, albeit with a lag, Cappelli argues.  This lag time might be reduced significantly if during a lay-off other key workers that the firm wishes to keep, start looking for new employment fearing that they might be the next to loose their jobs.  Thus, a growing concern for many managers is retention of key personnel.   The retention problem becomes even more problematic as business cycle conditions improve.

Solutions to these problems are not easy.  Firms could simply reduce their levels of lay-offs in hopes of reducing their retention problem.  However much of the retention problem maybe external.  As other firms in the market seek to hire new workers they will most often look to their competition.  Thus the retention problem is demand driven as well as supply driven.

If efficiency wage models are correct, a specific firm could reduce voluntary turn-over by offering efficiency wages.  The problem with this solution is the fallacy of composition.  While this might work for an individual firm it does solve the market wide problem.

The retention problem is not only a firm level problem but it is also a concern for the macroeconomy.  If retention is seen as a major problem employers maybe less likely to offer skill enhancement for employees. The fact is, most skills are not firm specific.  Thus, if employers fear current employees may leave the firm quickly the firm will not have the ability to reap the benefits of employee skill enhancement.  Thus, firms will be less likely to offer worker skill enhancement.  This then could have a huge negative effect on the entire U.S economy as on-the-job skill enhancement levels may be significantly reduce.

Thus, the lay-off driven, “flexible” American labor markets of today may not turn out to be as wonderful as the business press makes them out to be.  Just remember the “Japanese Management Miracle” articles of the 1980’s.

All the best,

MBrandl