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Like laboratory mice pushing the same button over and over again to get food, corporate executives often resort to the same tried-and-true tactics to try to help their stocks recover. What has worked in the past, however, is likely to backfire on them this time around.
You don't have to follow financial news closely to know that corporate America has been bleeding jobs left and right. Just this week, thousands of workers have gotten pink slips, with equipment-maker Caterpillar (NYSE: CAT ) topping the list at 20,000 jobs lost. Starbucks (Nasdaq: SBUX ) , Target (NYSE: TGT ) , and Time Warner's (NYSE: TWX ) AOL unit also added themselves to the long list of employers who've recently announced significant job cuts.
What's going on?
The layoffs seem like a natural reaction to falling profits. When times get tough, businesses look for ways to cut costs. Especially when business demand is down, reducing a company's workforce has an immediate and usually substantial impact on the bottom line -- which appeases investors and tends to boost share prices.
Or at least, that's how things worked in the past. The problem today, though, is that the economy is in a prisoner's dilemma. Companies rushing to minimize their individual losses are creating unintended consequences that will eventually do far greater damage.
Go ahead, everybody's doing it
When the economy is strong, a struggling company can take action on its own without worrying much about what its cuts will do. When Ciena (Nasdaq: CIEN ) laid off workers in 2004, it only had to worry about whether its own business and the telecom industry in general would recover. When both did, shares soared.
The same goes for Charles Schwab (Nasdaq: SCHW ) and its troubles five years ago. Once it emerged from the shadow of the tech bust, the discount broker returned to its roots and thrived in the midst of a huge economic expansion.
But now, everyone is trying to eliminate jobs at the same time. As a result, the typically beneficial effects of layoffs will quickly get overshadowed by the downward spiral that those layoffs trigger.
Businesses need customers
In the classic version of the prisoner's dilemma, two prisoners can either keep silent or confess. If they both keep their mouths shut, they both go free. If they both confess, they go to jail. But if just one confesses, the blabbermouth gets a much lighter sentence than the one who stayed silent.
With jobs, the dilemma is similar. If just a few businesses lay off workers, other companies can pick up the slack without too much effort, overall demand in the economy doesn't suffer, and the result is a big positive for the cost-cutting companies. But if a whole bunch of jobs get cut all at the same time, then you suddenly have a huge mass of unemployed workers who can no longer afford to buy the goods and services they did when they had jobs, and then everyone feels the effects.
If the layoffs are large enough, the problems can ripple outward throughout the economy. The businesses that used to serve laid-off workers will themselves have to cut back, and the cycle will continue.
Where it stops
The possible solutions are few and difficult:
- Businesses can try to find a market for their products whose demand won't be affected by layoffs. For instance, a foreign car company like Honda (NYSE: HMC ) can make workforce reductions in Japan without any impact on American demand. But laying off workers in its U.S. plants does potentially affect demand.
- Company management has to recognize that although keeping on workers may not maximize profits in the short run, the long-term consequences of shedding those workers will exceed the near-term benefits for their core businesses. That's contrary to the way most managers have been trained -- and more importantly, it relies on other businesses to act the same way.
To me, it seems unlikely that companies will be able to cooperate enough to keep from pushing the economy further downward. Eventually, someone will find a way to put all this newly available labor to productive use. But until that happens, you shouldn't expect a lasting economic recovery to take hold.
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