Next recession will push Gordon Brown's commitment to the limit

Diane Coyle on what will happen when boom turns to bust

Britain's economy is probably somewhere around the top of its boom, precisely the stage of the cycle at which optimism becomes irresistible. The time has therefore come for economists to do their duty and spread some gloom about the prospect of a recession. No Chancellor likes a recession, but it will be particularly testing for Gordon Brown given that he has promised a long-term improvement in Britain's economic performance and made a new commitment to full employment. For recessions, of course, bring falling growth and rising joblessness.

Mr Brown deserves full marks for addressing the economic issues that are of most concern to the electorate - the deep, underlying issues of productivity, inequality and jobs. Too often in the past policymakers have focused entirely on things that are not quite so hard to influence, such as GDP and inflation, even though these are at one remove from what really concerns people. But improving Britain's record on job creation and income inequality will prove a long haul, and concentrating on them will not allow the Government to avoid the problem of managing a recession.

How, for example, will a Government committed to full employment, however that is defined, react to the redundancy programmes that the next downturn will bring? Evidence in a book published today on how companies cope with a recession offers some tantalising hints about how Mr Brown might start to address this.

The key point brought out in the book*, co-authored by Paul Geroski, a professor at the London Business School, and Paul Gregg, an adviser to the Chancellor, is that a downturn does not affect all companies equally, and relatively few suffer enough to axe a lot of jobs. The results, from a detailed survey of more than 600 firms, are startling.

They show a large amount of job churning concentrated in relatively few companies. Even in the most prosperous boom years nearly one-third cut jobs. On the other hand, during the 1991-92 recession, two-fifths did not reduce their level of employment, and even in 1981 one-quarter of firms did not shed labour. The swing from boom to bust switched about one in five companies from hiring to firing and left the other four out of five doing whichever they had been doing anyway. The authors write: "Employment growth and contraction are highly concentrated in a small number of firms who experienced big changes in employment in booms and recessions."

Of the 2,100 firms which provided information for the years 1989-91, only one-half cut jobs. Nearly 90 per cent of the job losses, which amounted to a net 361,000, occurred in 56 firms - that is, in just one-tenth of the sample.

The book goes on to investigate why some companies are much more vulnerable to downturns than others, with only half of those questioned claiming to be severely affected. Performance during the preceding boom seems to offer little clue to how well each firm copes with the bust. Some of the laggards during the recovery survive while apparently thriving ones swing the jobs axe savagely.

Large companies seem more at risk than small ones, contrary to popular impression. Holding companies and highly diversified ones were also less robust. So were those that had expanded rapidly, often by takeover, taking on a lot of debt, although their vulnerability seems to be mainly a matter of unlucky timing in having their growth spurt too close to the point where the economy turned down. But beyond establishing that the variation in performance between companies has increased over time, these results are not especially revealing.

More interesting is the way firms react to recession. Uniformly, they try to cut costs by cutting jobs and limiting wage growth, and by reducing investment in plant and equipment, but not investment in intangibles such as advertising, marketing and R&D. Nor do they cut dividends. In other words, the two recession strategies they opt for are precisely those least helpful to Mr Brown's long-term aims of sustaining full employment and boosting long-term growth. What's more, the two economists report that the job shedding has only a temporary effect on productivity, or output per employee.

There is a puzzle in these findings. Why do a small minority of companies find it easier to sack a few thousand people than reduce their dividend bill? Wouldn't a bit of financial engineering be easier and better for the business in the long term than losing human capital and damaging morale? Evidently not, although the book provides some evidence that a strong union does make firing people less of an easy option. These findings will fuel the Government's determination to press on with corporate tax reform in order to shift the burden of risk-taking away from employees and on to shareholders.

But would using the tax system to reshape the way companies cut costs during a recession be enough to meet the pledge to keep the economy close to full employment? Probably not. One issue is what full employment means.

A more fundamental point is that unemployment is not a problem of companies making too little work available; the conventional wisdom that unemployment just reflects inadequate labour demand is wrong. It is easy to stimulate demand. If Mr Brown wanted to avoid a recession, he could allow more public spending or cut taxes. The difficulty is that simply expanding demand would run the economy into the supply buffers and lead to inflation. Solving the unemployment problem also requires the expansion and improvement of labour supply.

America's great achievement has been to draw into work more categories of people who were not previously participating in the labour market. They are often on low pay but their entry into work has allowed demand to carry on expanding without triggering inflation.

Tackling British unemployment will similarly involve getting people who have not typically worked into jobs on, probably, low wages, or improving their skills enough to warrant taking them on at higher wages. For all the Government's brave talk about reskilling the workforce and its welfare- to-work programmes, they will be lucky indeed if it happens in time for the next recession.

* "Coping With Recession", Paul Geroski and Paul Gregg, Cambridge University Press pounds 40 or pounds 14.95.