Not Hiring is Contagious
A theory of recessions
Being CEO of an established business is an inherently conformist job. If other firms are heading South, then a contrarian would say “Let’s head North.” But instead, if you are a typical CEO you will say “Let’s head South like everyone else.” If everyone else is correct, then you are making the right decision. If everyone else is wrong, then you will not stand out from the crowd as looking especially dumb. But if you say “Let’s head North” and you are wrong, then you stand out as a fool. And even if you turn out to be right, then you may be marked as not being reliable and put on a sort of watch list.
So suppose that as CEO you read in the newspaper that everyone else is not hiring new employees, and instead they are starting to implement AI. A contrarian would say, “Now is the time to hire new employees, because it is a buyer’s market for talent.” But real-world CEO’s are not contrarians. They are conformists.
Mark Zandi writes that we are on the precipice of a recession. The indicator he cites is that, in July, 53 percent of industries were experiencing a fall in employment. I agree that this is an ominous indicator.
My heterodox view is that there is no such thing as “aggregate demand.” Instead, there are Patterns of Sustainable Specialization and Trade. Increases in employment come from new attempts to find PSST. Decreases in employment come when existing patterns become unsustainable.
At the margin, animal spirits play a big role. Nobody knows for sure if new hiring is going to pay off. Nobody knows for sure if the existing work force is too bloated. As Garett Jones sagely pointed out years ago, typical workers do not produce widgets. They build organizational capital. But nobody knows for sure if that new project or new process or new communication system will pay off. Nobody knows for sure whether Arlen in Compliance is helping to save the company or wasting its money.
The world of precise calculations of marginal product exists only in economic textbooks. In actual business, decisions to hire and fire depend on mood and guesswork. All we know for certain is that the discipline of profit and loss means that patterns of sustainable specialization and trade will persist, while patterns that are not sustainable will at some point fade away.
A problem with PSST is that it has no theory of recessions. We can describe a recession as a phenomenon in which patterns of trade suddenly fall apart across more of the economy than usual, by more than can be offset by the creation of new patterns of trade. But why would this happen?
That is where CEO conformity comes in. A signal goes off that tells CEOs that it is time for animal spirits to freeze up. “We’re in a financial crisis!” or “We’re in pandemic lockdown!” I am not denying that some patterns of trade became unsustainable during the crisis of 2008. But the increases in layoffs and decreases in hiring strike me as having gone well beyond the housing sector and Wall Street, where the damage was immediate and direct. Since I do not appeal to “shortfall in aggregate demand,” I explain the process as a contagion of not hiring. CEO’s gave themselves permission to hunker down and cut costs. “We’re in a recession” became a self-fulfilling story.
What about now? If the Bureau of Labor Statistics were telling us that employers are expanding, then CEO’s might believe this, and that would stop the spread of contagious falls in employment. So President Trump is on the right track in firing the BLS chief! (I’m kidding.)
Is AI starting to adversely affect the labor market?1 Are tariffs starting to adversely affect the labor market? The direct effects may be small. But the CEO contagion effects could end up being large.
These economists say “no clear signs of disruption…yet.”
Re: corporate decision contagion: there is a lot of board/CEO incest across major companies, so that when one board affirms a consensus, it is likely to be reaffirmed across nominally different boards and executive teams if only because the memberships can be charted in a one-circle Venn diagram. They also all have the same bankers, listen to the same analysts, and hire the same consultants.
Two points:
1: I think you are right on CEO/management herd behavior. I recall in 2008 the company I was working for laying off a TON of people suddenly, including many people who everyone knew were bad yet just kept passing around different departments. I believe part of that was emotional aversion to firing anyone being relieved by having a good excuse ready when you had to tell the person. "It isn't that you don't do anything and slow everyone else down, it's this economy thing. What can you do?" Likewise, if you have to explain to people why your company is suddenly shedding people, or why they have to cut their team, a widely publicized recession makes it easier to not look like a failure as a leader when you do.
2: Your PSST theory doesn't need special theories about recessions, all it needs is differing rates of growth and decay of PSST. Consider the analogy of a wooded island. Over the years lots of animal and plant life has grown and flourished and there is a fairly stable little system. Some years there are more squirrels, some fewer, but overall pretty steady. Then one hot, dry summer lightning hits one of the larger dead trees, a forest fire starts, and lots of damage is done to surrounding flora and fauna. In a day lots of life can be stripped away, but how long does it take for the plants and animals to get back to roughly the same numbers they were before? Not infinite time, but not one day, either.
Put another way, it is easier to break existing PSST than it is to build new ones, so a sufficiently large disruption can knock a lot back all at once.