If you believe the press and the Fed, the unemployment rate is an important barometer of our country’s economic “health,” as low unemployment is considered a positive sign. It seems natural to think that if more people are producing goods and services, we should be more productive as a nation. But in reality, things are not so simple.
Except during a recession, Wall Street loves layoffs
It sounds harsh, but it’s true. When things are going well for a firm, an announcement of layoffs almost always leads to an immediate jump in that company’s stock price. Is this because Wall Street analysts are greedy bastards, and only care about the higher profits that will result from a decrease in compensation costs?
Well, partly: Lower costs boost a company’s bottom line, causing the intrinsic value of the stock to increase. But cost reduction is only one factor in a much richer picture. We’ll use Hewlett-Packard Company’s (NYSE: HPQ) recent earnings announcement as an example of how to view layoffs in a successful firm.
HPQ delivered slightly disappointing earnings on May 22, which resulted in a -2% decline in its stock price. The next day, the company announced that 11,000-16,000 employees would be laid off in the near future, sending the price up +6.1% from the prior day’s close.
HPQ’s May 2014 closing price of $33.50 represents a total return (capital gains + dividends) of +195% from the stock’s low point of $11.71 in November 2012. While HPQ still has long way to go to achieve its restructuring goals, it’s safe to say that HPQ is no longer in a “desperate” situation where job cuts are necessary. So why is HPQ laying people off during a period of prosperity, both for the company and the US economy?
 The main exception to this is during recessionary periods such as 2008-09, when companies are forced to lay off employees because of falling sales (revenue). This article focuses on the effects of layoffs in growing companies during prosperous economic periods, such as today.
Better, Cheaper, Faster—and with fewer workers
The answer is “Productivity.” (Remember the movie “The Graduate?” Back then, the secret word starting with “P” was “Plastics.”) Ever since the Industrial Revolution began about 150 years ago, technology has enabled us to produce progressively more with fewer workers. Agriculture, not typically considered a cutting edge industry, serves as a perfect example.
Since 1948, the number of agricultural workers in the US has declined by 3.2% per year, representing a -88% decrease in the agricultural workforce. With so many leaving the farms and moving to the city, you might think we would all be starving by now. But technology, from the cotton gin to automatic milking machines has dramatically increased the productivity of each farmworker, such that food output increased by 1.7% per year (+199% overall) during the same period. The graph below shows the decline in the labor force against the total output of the agricultural sector (with both labor and output starting at an arbitrary index level of 100).
In every industry, as technology improves, processes become more efficient and less labor-intensive, reducing the number of workers needed to produce the same—or, even greater—output. By laying off workers during good times, HPQ thinks it can continue to grow and produce even more “stuff” with a smaller labor force. If the layoffs had come about out of necessity, investors would have seen this and likely pushed the stock price down instead of up.
The economist’s point of view
Economists don’t look at people as individuals; rather, they look at them as an input called “labor”, with “capital” being the other major input, and “goods” or “services” the output. (No wonder economics is called the “dismal science!”) So while most of us, not being economists, hate to see our friends and family being laid off from jobs, these dismal scientists see it as a natural part of the growth cycle. From the economist’s standpoint, when HPQ lays off employees, it’s because the firm’s resources are not being optimally deployed, with too much of them going towards labor. This is because increases in productivity have allowed HPQ—and many other companies—to produce more stuff with fewer people.
Those employees who lose their jobs at HPQ—in this case, most likely skilled ones—will eventually find new jobs and will receive any necessary training for their new position. That additional training, and the placement of these workers in positions within firms where they are needed, makes them more productive and a greater contributor to our economic progress as a whole.
For workers, in general and over time, as machines take over more menial jobs and the skills required of employees become ever more complex, it means higher pay and a better standard of living. Periodic layoffs are one of the prices we pay for the technological and economic progress that eventually benefits everyone. The key for the worker, of course, is education and training: if you don’t have the skills needed in our modern economy, you’ll never find that better and higher paying job, but will instead move down the latter or become one of the long-term unemployed.
Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®
Founder and President – Kenfield Capital Strategies (KCS)
Director of Business Development – Kenfield Capital Strategies (KCS)
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