The Recession May Be Over Before Its Work Is Done

The war is over. The recession is not.

The quick and overwhelming end to Operation Desert Storm has quieted the doomsayers, and while tangible signs of recovery are still scarce, the economic downturn now looks much more manageable. With the consensus forecasting a midyear recovery, disagreement between pessimists and optimists has been reduced to a matter of a few months--the difference between a spring upturn and one that starts in the early fall.

A short, shallow recession is surely preferable to the sharp decline that many feared. Still, there's a catch. Hard times, if they're bad enough, can quickly wring out overcapacity and pave the way for a strong recovery. But so far, this recession is taking a much slower route. Finance, retailing, and other services are only now starting to slim down, and many companies will be under pressure to keep laying off employees after the recession is officially over.

FAILURES APLENTY. The steep 1981-82 downturn is a classic example of a recession that cleared away large swaths of excess and uncompetitive capacity. During that slump, manufacturers sliced their employment by more than 11% in just 16 months. Since September, 1990, by comparison, service sector businesses have lost only 0.1% of their workers. Even the finance industry, pounded by a weak real estate market, bad loans, and the thrift debacle, has held on to almost all of its work force. Wall Street firms and New York banks have made deep staff reductions, but nationally, employment in that industry has fallen by just 0.4% since the summer, according to the Bureau of Labor Statistics.

Overall, the unemployment rate has risen by less than a percentage point since the summer (chart). Managers and professionals, ostensibly hard-hit by white-collar cutbacks, have seen their unemployment rate rise only slightly above its level at the beginning of 1990. And according to a new forecast from Laurence H. Meyer & Associates, the peak unemployment rate in this recession, on a quarterly basis, will reach 6.7%--far below the 10.7% recorded in the last quarter of the 1981-82 recession.

Even the soaring rate of business failures--up by a staggering 38% since last year--doesn't translate immediately into fewer competitors. With the exception of Eastern Air Lines Inc., almost all of the large companies that have recently filed for Chapter 11 bankruptcy protection are still in business. Federated Department Stores and Allied Stores Corp., for example, have been operating in Chapter 11 since January, 1990, but they've closed only 17 of about 250 stores. In the airline industry, both Pan American World Airways Inc. and Continental Airlines Inc. continue to fly. And thanks to government backing, Bank of New England Corp. and other insolvent banks are open for business.

But the slow pace of the cutbacks so far doesn't mean they will stop once the recession is over. Overcapacity still afflicts this economy. There are too many banks and stores, and a half-year of recession certainly hasn't been able to make empty office buildings and unsold homes disappear. That means even if the downturn were to end tomorrow, service-sector businesses would still be cutting back in order to restore profit margins that have been shrinking over the past year.

FACE SLAP. And their problems go beyond just overcapacity, warns Stephen S. Roach, senior economist at Morgan Stanley & Co. U. S. service industries also face the threat of increased foreign competition at home and abroad. In recent years, foreign companies have enthusiastically bought up U. S. retail chains, hotels, and other service businesses, spending almost as much money as they did on factories. If the experience of manufacturing is any guide, competition with foreign-owned service businesses is going to spur cost-cutting and productivity improvements.

Still, the recession does have an important role to play, since there's nothing like a slap in the face to get someone's attention. Just as the recession of 1981-82 woke up manufacturers and eventually led to their resurgence in the second half of the 1980s, so might this downturn help shake up service companies. "The recession is providing them with unmistakable clues," says Roach. "It's bringing the reality of the problem home with a vengeance." If the service sector heeds these messages, this recession, no matter how short or shallow, will have set the stage for growth.

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