HR Leaders and Economic Policy

Stimulus packages and money supply issues may seem off the beaten path for HR leaders, but there
are important implications for workforce planning. Will business continue to deteriorate and will
more layoffs become necessary? When will the rebound and hiring start?

By Peter Cappelli

Eighty-thousand people were laid off on Monday of last week, in case you had any doubts that the
economy is in real trouble.

We don't know what causes most recessions and subsequent recoveries, a fact that surprises and should
scare us.

We know a bit more about how to get out of them. John Maynard Keynes wrote in the context of the Great
Depression and laid out the framework for understanding business-cycle economics. In particular, he
described how the supply of money affects interest rates, which in turn affects investment and economic
growth.

Managing the money supply, and through it interests rates, is a very practical and sensible way to manage
the economy. But he also argued that there was an important role for "fiscal policy," which meant
government spending, to stimulate the economy.

In particular, there were moments of severe economic decline where there was a "liquidity trap," a situation
where interest rates were already so low that the only place they could go was up, and monetary policy
would not work because no one would want to buy bonds (knowing their price would fall as soon as
interest rates rose). The term now is taken to mean a more general situation where monetary policy no
longer works.

A generation later, Milton Friedman and Ana Schwartz did their famous work on the Great Depression,
finding that it was the collapse of banks and the subsequent steep declines of the money supply that caused
the Depression and not the stock-market collapse. Out of this study came a much stronger case that
monetary policy alone could manage the economy.

This point is also where politics enters the discussion. Liberals tended to be happier with fiscal policy
because they were OK with a bigger role for government; conservatives were critical because they were not
OK with a bigger role for government.

Over time, monetary policy became the single tool for managing business cycles because of growing
confidence that it was more effective and easier to use. It was also because of a shift toward the
conservative direction in politics since the 1960s.

There were also practical objections to fiscal policy: It took a long time to put government-spending
programs in place, a long time to end them and the great concern was that it would be mistimed -- really
taking hold only when the economy began to recover anyway.

There is also a political debate around monetary policy -- conservatives tend to be more worried about
inflation and the negative effects it has on savings and investment (e.g., why save if our money will fall in
value); liberals more concerned about unemployment.

Tax cuts became a part of the policy debate more recently, but it is really more a debate about politics than
economics. Tax cuts stimulate the economy, assuming they are not offset by cuts in government spending.
They are less stimulative than the equivalent amount of government spending because individuals save
some proportion of any tax cut they get, but they are more popular politically than government spending.
There is no evidence for the idea that tax cuts raise more money than they lose in terms of revenue.

At the moment, we have a twin problem. The financial crisis in the summer and fall was caused by a
breakdown of confidence in the financial industry. Incredibly complex financial instruments based on
mortgages whose risk is hard to track, unreliable ratings agencies that assess risk, and outright duplicity
combined to make it difficult to know what the risks of various financial assets were.

They stopped being traded, and as a result, they effectively had no price. Banks were sitting on lots of
them, and the "mark to market" requirement meant that the banks suddenly had assets that appeared
worthless. They stopped making loans, in part because they didn't have enough reserves. Without loans, we
soon had a second problem, and that is a recession in the "real" economy: We know what caused this one.

Efforts to deal with the lack of confidence in the financial sector haven't worked. Because of that, low
interest rates designed to stimulate the economy haven't worked, either. It looks like the classic liquidity
trap. And this is quite scary, like having a patient with an infection that doesn't respond to antibiotics. The
(almost) universal call for government spending to stimulate the economy is not because it's the preferred
option, it's because it is the only option left.

Pundits are objecting to the stimulus package in part because they object to bigger government. It is
certainly true that the government borrowing required to fund all this spending could create a long-term
problem -- driving up the cost of borrowing for the private sector -- but that is a longer-term concern once
the economy gets going again.

The argument for tax cuts instead of government spending is, again, really a political debate. And the idea
that the economy will simply right itself if the government does nothing, as I've recently heard some
pundits argue, is a wild notion that, frankly, has never been tried and discounts the cost to society of a deep
and prolonged recession. It's really a political argument.

Even given the stimulus package, the confidence problem in the financial sector will remain. Giving banks
money didn't work, apparently because it wasn't enough, at least the way it was given. Solutions like having
the government buying up the "toxic" assets that aren't trading -- the original bailout plan -- are being
talked about again.

The Resolution Trust Corp.'s program of buying up foreclosed real estate in the mid-1990s provides a
model, although it is much, much easier to establish prices for real estate than for the distressed, mortgage-
backed assets. It's possible that government spending alone might pick the economy up even with this
confidence problem, but it will take more spending and more time.

So we're in a real pickle. It's not just "negative reporting," as I heard a business group last week say. The
last time we saw a situation like this was in the Great Depression.

The important implications for HR center on workforce planning: Will business continue to fall and will
more layoffs become necessary? When will the rebound and hiring start?

Forecasts are pretty worthless at this point.

We're watching for these things. The first is the layoff pattern. Layoffs are not necessary for the economy
to recover, they make things worse as they represent cutbacks in spending first by the companies and then
by the laid-off employees. The eruption of layoffs that we had last Monday will lead more firms to lay off
as they feel the first group knows something they don't.
The second is the stimulus package -- the longer it takes to deliver it, the worse things will be, in part
because confidence remains low until it happens. It will take a long time for the stimulus effect to begin
working -- at least six months or so after the actual spending begins. The biggest effect of it should be
whether people start to believe that it will work.

And that takes us to the great intangible: confidence.

The key thing to watch is the national mood. Opinion polls will be more useful here than business
forecasts. If businesses start to believe that the economy will rebound soon, they will stop laying off, start
making some investments again and we will be on the road to recovery.

As soon as that happens, the economy may well take off like a rocket because the massive monetary
programs that have been underway, not only here, but in most countries in the world will kick in, along
with the stimulus package.

It may also be hard to stop that rocket, which raises a longer-term concern about tight labor markets and
inflation. (As a point of perspective, though, we haven't had a serious inflation problem in a generation.) In
the last recession, 2001, employers were able to squeeze current employees to work harder and longer for a
good six months or a year into the expansion before having to hire.

My guess is that it will happen much faster this time. Let's hope it does.

Peter Cappelli is the George W. Taylor Professor of Management and director of the Center for Human
Resources at the Wharton School of Business. www.talentondemand.org .

Reader Feedback

February 2, 2009

Copyright 2009© LRP Publications