In what shape will Indian industry be, when the economy emerges from the recession? Will industry have gone through a useful cleansing? Prompted by adversity, will firms have restructured and re-organised, raised their game, and be better placed for growth? Or will the recession have forced firms to cut into their muscle, not merely fat, neglecting strategic investments in technology, human and physical capital in their efforts to control costs? Will they thus have sacrificed long run competitive ability? Is the economy?s long-term growth potential compromised?
At this point, we do not know with much confidence?these questions should be high on the agenda for economic research. A useful model for such research is the work of Paul Geroski and Paul Gregg who analysed firm experiences through the 1989-1991 recession in the UK. They surveyed 600 medium-sized firms in detail to find out how they had fared in coping with Recession. Some of their findings are relevant to the current situation.
All firms reassessed corporate strategy and focus, whether or not they felt themselves affected seriously by the recession. Almost all firms modified management methods, marketing, organisational procedures, rethought product lines and explored potential for mergers and acquisitions. Not surprisingly, the first and primary response of firms that considered themselves seriously threatened by the recession was cost control, mainly through labour reorganisation (employment cuts, wage growth cuts, business unit closures). Finance responses?disposing assets, reducing dividends, rescheduling debt and such?took the backseat to cost
control. The workforce took the brunt of the adjustment.
What is particularly significant however, is the high degree of heterogeneity in investment behaviour of firms. Recessions do not have the same effect on all firms. Many firms postponed major investments, but there were also firms that brought forward strategic investments, transforming activities rather than cutting them back. Investments that involved reorganisation and redeployment of existing assets, with potential for only longer-term pay-offs, were more likely to be brought forward in the face of recession. This included R&D and product and process innovations.
One consequence of such diversity in investment behaviour (this holds across other recessions, too) is of great significance: performance differences between firms increase significantly in recessions. While the average profitability across firms tracks the business cycle faithfully, the variation in profitability across firms rises sharply in the downturn. In the 1989-1991 recession in the UK, 10% of firms accounted for 83% of the gross fall in profits, with 20% accounted for 92% of the gross fall. The worst-hit 10% of firms also accounted for 85% of the gross fall in employment. At the same time, 40% of firms saw their profits rise in the recession, and half raised employment.
This diversity is an important aspect of firm and industry dynamics seen at all times: even within very specific sectors (say, outer wear garments), and in specific locations, firms vary hugely in performance and in potential at any time. Increased variability in firm performance sets the stage for some firms to grow and some to contract or exit, and for new firms to enter. This is the way productivity grows?through entry and exit, and changes among surviving firms. These everyday evolutionary processes of selection by the market is amplified as the economy emerges from a recession. Increased variation across firms in recession sets the stage for the market selection processes that increase the average quality of technological, human and physical capital in industry. This brings about the prospect of increases in the economy?s long-term growth potential.
What is different this time around is the dearth of investment funds. Some great firms are on the verge of being born, and some currently unnoticed firms are on the cusp of taking off (by challenging the old business models of current market leaders who are not coping very well). But in the upheaval these potential winners are very hard to identify. Indeed it has been hard to predict which firms precisely would suffer most heavily in the recession?pre-recession profits and sales were weak predictors of suffering. Many investment agents are crippled with debt, and capital inflows are sharply down. The financial system is rife with pessimism and risk aversion. All the while eventual winners remain unbacked and stunted, the national level opportunity of raising the long term growth potential the economy as a whole is wasting away.
The author is reader in economics at the Judge Business School, University of Cambridge, and fellow of Corpus Christi College