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HR Magazine, January 2001: Looking for Trouble

By Susan J. Wells  1/1/2001
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HR Magazine,   July 2000 Vol. 46, No. 1

In our increasingly complex economy, the next downturn may be more challenging than previous ones.

Now in a record 10th year of unbroken growth, just how long can the steady pace of the U.S. economy continue with the lowest unemployment numbers in three decades and tame rates of inflation? It’s a question that’s foremost on the minds of economists and employers as the new year begins and a new president takes office.

Looking smart in an expanding economy is easier—at least partly the result of being in the right place at the right time. But economic cycles have not been repealed and, inevitably, the economy will take a turn someday—perhaps sooner than anyone expects.

What happens when the boom times end? How will HR help employers adapt?

Economists say that several aspects of the recent hot economy make the prospects of a downturn potentially more challenging and troubling for HR than in prior slow-growth or recessionary periods.

Why? For one reason, dramatic changes in the "New Economy" and the modern workplace—in which scarce, highly skilled workers have been courted with record compensation and benefits packages—have put labor in control of a sellers’ market. For another, economic indicators are increasingly difficult to use as long-term navigational tools, as evidenced by the daily gyrations of the stock market and the increasingly fickle nature of consumers.

Here’s an overview of key trends to watch—and the danger signals they may flash—to help you keep an eye on this increasingly complex economy and how its twists and turns may affect your HR goals.

Productivity Gains Cushion Costs

The reasons for the economy’s enduring strength are many, of course. One of the most striking has been companies’ ability to log impressive productivity gains—which have so far been credited with keeping benefit and compensation costs at manageable levels and holding inflation at bay.

With significant gains in productivity—measured in output per hour worked—companies can afford higher employment costs. The reason: Increasing productivity allows businesses to boost output faster than the rise in compensation and benefits costs—and that enables them to keep prices for goods and services in check. In other words, the cost of labor is directly linked to productivity.

For three years, productivity has risen faster than compensation, letting businesses pay employees more while maintaining or increasing profits. By keeping corporate profits strong, productivity growth helped spur the stock market to historic highs. But a big increase in wages and benefits costs, a significant slowing of productivity gains—or both coupled together—could undermine the stock market and slow business and consumer spending. And those events can stall the economy.

The Employment Cost Index (ECI) for all civilian workers—private industry and government—in September 2000 was 149.5, an increase of 4.3 percent from September 1999, the U.S. Bureau of Labor Statistics (BLS) reported in late October. The ECI measures changes in compensation costs, which include wages, salaries and employer-paid benefits.

Employment Cost Index

12-month changes in employment costs for private industry, which excludes state and local governments.

  Sep. 95 Sep. 96 Sep. 97 Sep. 98 Sep. 99 Sep. 00
Total costs 2.6% 2.9% 3.2% 3.8% 3.1% 4.6%
Wages, salaries 2.8 3.3 3.6 4.3 3.2 4.1
Benefits 2.1 1.8 2.0 2.6 2.8 6.0
Source: Bureau of Labor Statistics

In private industry, wages and salaries rose 4.1 percent for the 12 months ended September 2000, after increasing 3.2 percent in the year ended September 1999. But benefit costs for private industry workers increased more, rising 6 percent for the 12 months ended in September 2000—a significant hike from 2.8 percent in September 1999.

If benefits costs continue their rise, some economists say, real wage gains would be more likely to erode than to trigger inflation. The end result: When more money goes to benefits, less goes to wages and salaries.

Stock Market Jitters

Despite the apparent health of the productivity and compensation numbers, the gas seems to have gone out of the market over the past year. Since last spring, technology, the stock market’s main power source during the last five years, has fallen on hard times, and, as of Nov. 30, the S&P 500 index had gone 33 weeks without reaching a new high. Since 1990, that’s happened only once—in 1994.

Why is this so important? In the last recession, which began in 1990, technology made up less than 5 percent of the total annual change in Gross Domestic Product—the nation’s total output of goods and services and the broadest measure of economic health. Today, it comprises somewhere between one-third and one-half of the growth in GDP.

Any softening of a dominant market sector like that can lead to further volatility, making both investment managers and employees more likely to shift from economically sensitive stocks into more conservative ones, as well as bonds and cash.

"The equity markets today are simply more demanding of business performance," says Anna Rappaport, principal and worldwide partner at William M. Mercer Inc. in Chicago. "As economic and investment markets shift, HR will have to think harder about the compensation mix."

For example, when times are good, employees tend to value stock ownership or option programs. But when times turn sour, workers want cash. Rappaport’s advice: Ease up on stock-based retirement and incentive plans if the market calls for it. "Do a careful analysis of how equity price fluctuations will affect your compensation programs," she says. "And then have a backup plan in place to shift the risk appropriately."

Ripples in the Labor Pool

A key question is how any downturn will affect what has been the tightest labor market in history. While economic slowdowns almost invariably have led to layoffs, thus increasing the pool of available labor, there is some evidence that this time the past may not be prologue.

Annual Unemployment Rates

1990 5.6%
1991 6.8
1992 7.5
1993 6.9
1994 6.1
1995 5.6
1996 5.4
1997 4.9
1998 4.5
1999 4.2
2000* 3.9
*as of October

Over the past year, the jobless rate has ranged from 4.1 percent to 3.9 percent, and it is expected to remain low by historical standards as the growth of the nation’s labor force declines.

The workforce, 140 million in 2000, is projected to rise to just over 170 million by 2020, according to the U.S. Bureau of Labor Statistics (BLS).

But it will grow at a slower rate each year until then. Last year, the workforce was projected to grow by 1 percent, but projections are for it to increase by just 0.8 percent in 2010 and by 0.6 percent in 2020. The biggest reason for the deceleration: The impending retirement of the baby boomers.

"A lot of people think the tight labor availability problem will get better, but it just won’t," says Jeff Thredgold, an economist, futurist and president of Thredgold Economic Associates in Salt Lake City. "The biggest frustration for HR is the call from upstairs saying, ‘Why can’t you fill these jobs?’ "

Others see it differently. "In many respects, the nation is experiencing job less growth," James Paulsen, chief investment officer in the Minneapolis office of Wells Capital Management, wrote in the November 2000 issue of Wells’ Economic and Market Perspective.

From 1980 to 1984, during which two recessions occurred, each percentage point rise in GDP translated into a 0.61 percent gain in job creation. But since 1995, Paulsen notes, every percentage-point increase in economic growth has produced just 0.10 percent more jobs.

In the last year, for example, job growth has dropped off steadily to 1.8 percent, while real GDP growth has been about 5.5 percent. This trend, he believes, could make a softening economy translate into more job cuts than in previous slowdowns.

Partially explaining this anomaly: The practice of "churning," or simultaneously hiring and firing employees to match work needs as business direction shifts, or through mergers and acquisitions. Other reasons for the brisk layoff activity include the failure of some industries to benefit from the ’90s boom and the new economy.

Some analysts speculate that churning is on its way out because many companies already have experienced their reinvention—with the exception of the ongoing shakeout in the dot-com industry.

Announcements of job cuts through September 2000, as tracked by Challenger, Gray & Christmas Inc., an outplacement consulting firm in Chicago, totaled 392,296—30 percent fewer than the 556,729 cuts announced during the same period in 1999.

Most of those laid off have been able to find new jobs quickly. Of the 3.3 million workers who were laid off from January 1997 through December 1999, 74 percent were re-employed in February 2000, according to the BLS. The rates were even higher for workers aged 21-24 and 25-54: 88 percent for the younger group and 80 percent for the older.

However, if layoffs in the fourth quarter of 2000 followed the pattern of the last five years, Challenger estimated that more workers could be jobless heading into 2001. In four of the last five years, fourth-quarter job cuts exceeded those in the third quarter by an average of 40 percent, the firm reports.

This disparity in the data simply adds to the staffing dilemma that HR faces. With the pace of layoffs starting from an already higher level, the question will be whether HR managers continue to be a hiring force, despite a cooling economy, or become a firing force.

Susan J. Wells is a business journalist based in the Washington, D.C., area with more than 16 years of experience covering business news and workforce issues.

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