The Economy's Good News: The Upside of Downsizing

Policy Backgrounders | Economy

No. 146
Wednesday, February 25, 1998
by W. Michael Cox & Richard Alm

Rightsizing for the '90s

Figure II - Percentage of Employees in Establishments by Employee Size

"Without new technology, long-distance calls would cost six times as much and requires 3.6 million operators."

Shedding labor allows companies to adapt to changes in the marketplace. More often than not, downsizing is a matter of sheer survival. Companies with surplus labor usually have higher production costs and risk losing business to "lean and mean" competitors that can lure away customers with lower prices. Market discipline - in effect, consumers' scrutiny - pushes relentlessly at companies, forcing them to economize on resources, including labor.

Trend Toward Smaller Firms. Each company must determine its own "right" number of employees, but there is evidence that average firm size has been shrinking in most industries. In effect, the whole economy has been downsizing.

  • From the early 1960s to 1980, the average company grew from 13.0 employees in 1962 to 16.3 in 1970 and to 16.5 in 1980. At the peak in 1970, roughly 37 percent of Americans worked in firms of 250 or more employees [see Figure II].
  • In the past decade or so, the trend has gone the other way. The average number of employees per firm slipped to 14.8 in 1993 with only 29 percent of workers employed by firms of 250 or more.17

"The average firm size has been shrinking; in effect, the whole economy has been downsizing."

Downsizing has occurred in a broad spectrum of industrial categories - manufacturing; mining; construction; agriculture; wholesale trade; finance, insurance and real estate; and transportation, communication and public utilities [see Figure III]. Average firm size has continued to grow in only two broad sectors. Retail trade went from an average of 12.3 workers in 1980 to 12.7 in 1993. Companies in the catchall category called other services, which includes the health care, entertainment and information industries, expanded from 11.3 to 14.1 employees on average.

Figure III - Average Employees per Firm by Industry

Computers Increase Productivity. Why are companies getting smaller? One reason may be the computer, an innovation that has touched many industries.18 Computers were rare two decades ago but are now almost ubiquitous. In fact, half of American workers now use computers on the job. The devices have become less expensive and more powerful as they have become widespread, allowing people to work more quickly and efficiently - increasing productivity. For example, with a computer a secretary can quickly revise and print the boss' correspondence (or workers can do their own), reducing the need for a typing pool. Using hand-held devices, salespeople can submit orders with a keystroke or two, cutting the need for personnel to process paperwork. In steel mills, automobile plants and other factories, computers control the production process, allowing one technician to do what once took dozens of workers. And with the advent of the Internet, individuals are increasingly able to locate and download information that once might have taken a small staff.

"Only in retail trade and the catchall 'other services' category has the number of employees per firm grown."

The computer might also help to explain why the average firm size in retail and many other services hasn't declined. More than mining or manufacturing, these businesses rely on one-on-one contact with customers, a task ill-suited to the computer. Thus, firms in these sectors do not get the same benefits from trimming employment.

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