Airlines, autos: You can't cut your way out of crisis

From autos to airlines, desperate executives are wielding a mighty axe in an effort to survive the devastating consequences of the global recession. The common assumption is that "getting viable" is synonymous with "getting much smaller." In wildly swinging the axe as a solution to corporate woe, the downsizers are felling many trees -- but missing the forest.

Consider last week's stunning events at two of Canada's largest employers: General Motors and Air Canada.

On March 29, GM's CEO, Rick Wagoner, was fired -- not by directors or shareholders but by Barack Obama. Analysts felt Mr. Wagoner was "too slow" to downsize. This view was reinforced by the demand from Mr. Obama's auto task force (mostly financiers) that GM must cut deeper (more closures and cutbacks) to prove its "viability."

Of all the things Mr. Wagoner can be accused of, failing to downsize is certainly not one of them. GM lopped more than 100,000 positions from its U.S. work force since 2001 (more than half). In Canada, GM's manufacturing work force is slated to fall (including plant closures already announced) to about 6,000 (compared with 22,000 a decade ago).

Yet, the more GM responded to tough times by shrinking, the worse things got. Fixed costs (for engineering and design, capital, marketing and retirees) got bigger per unit of output, not smaller -- making it all the harder to develop and manufacture competitive products. GM's experience proves forcefully that you can't dig your way out of a hole -- yet, Mr. Obama's task force tells GM to keep digging. Soon a point of no return is passed, below which the company's critical mass (its ability to design and manufacture innovative products) is destroyed.

Air Canada is a different company, in a different industry, but equally epitomizes the impossibility of shrinking your way to viability. Air Canada's CEO, Monte Brewer, lost his job one day after Mr. Wagoner. (And, like Mr. Wagoner, he was replaced not by a hands-on manager but by a financier.)

Everyone expects the new CEO, Calin Rovinescu, to fly Air Canada back into bankruptcy protection (right where he left the airline when he last worked there in 2004). Then, under court protection, he will axe much of the company's operations and go after key contractual commitments (such as its partnership with Jazz and its pension plan). The only question is how much he will cut, and where, in this latest effort to become "viable" (that is, "smaller").

Air Canada's workers and other stakeholders lived through this same horror movie six years ago. It didn't work then, and it won't work now -- for the same reasons why GM's continuing cutbacks are also doomed to failure. Despite sacrifices from employees, Air Canada's unit costs (excluding fuel) increased slightly since exiting bankruptcy protection in 2004. Why? The negative impact of shrinking capacity on unit costs outweighs the savings extracted from the hard-pressed work force. In airlines, as in autos, you can't cut your way out of crisis.

If we want to maintain a stable auto or airline industry in Canada, we must resist the knee-jerk tendency to respond to adversity by slashing and burning. We need a strategy that builds, not cuts. That's a better way to save critical companies. And it leaves the overall economy better prepared for the next upswing.

Any single business responds to tough times by cutting back and laying off. Yet, the sum total of those individual acts, multiplied across the whole economy, worsens the recession that threatens each business's survival. This collective irrationality is why government economic leadership is so essential during crisis. Government is the only force in society with enough foresight, fiscal staying power and (we hope) accountability to the broader public interest to respond to crisis by doing more, rather than less.

So whether it's autos, airlines or any other fragile sector, government's role is certainly not to reinforce private-sector irrationality with demands for even more cutbacks. Instead, government should promote building. It should stabilize demand (in autos, by guaranteeing warranties and subsidizing the scrapping of old clunkers). It should relax the do-or-die competition that exacerbates the carnage (in airlines, by limiting the continuing overexpansion of capacity in an industry already drowning in red ink). And it can bridge key companies into a more optimistic future with loans, technology and partnerships.

Otherwise, the axe will keep swinging, and the economy will keep tanking.

Jim Stanford is an economist with the CAW.

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