Are you looking for advice related to the Coronavirus? This post was written in January 2020 before the outbreak of the pandemic. For updated information and guidance, please see our newest post: What is the Current State of the Economy and What Does it Mean for Compensation?
No one knows definitively if an economic recession is coming in 2020. At the end of 2018, there were many market indicators that a recession was looming, with economists speculating that a recession would hit sometime in 2020 or at least in 2021, but that dread lifted — or at least became uncertain — by early January 2020.
In order to judge whether a recession is coming, economists look at several indicating factors, but one of the most prominent is the Treasury Yield Curve.
The Treasury Yield Curve is a line chart showing the return on investment from government bonds with the yield of fixed-interest rates (Y-axis) plotted against the time bonds have to mature (X-axis). In a healthy economy, the yield curve is upward sloping, showing that the rewards for investing are high and increase over time. However, when the curve inverts, the return on investment drops. The curve dips deeper when the investment becomes increasingly less profitable with longer waiting times to make a return. Historically, a recession follows inversion because people stop borrowing and start saving. Economists tie the likelihood of recession — and the severity of the recession — to how deep the inverted yield curve becomes.
The Treasury Yield Curve inverted in March of 2019 and worsened over the summer. This is what flagged the likelihood of an economic recession coming in 2020.
Understanding Natural Economic Expansion and Recession Cycles
Economies are cyclical. Booming markets last for an average of 3.2 years. Recessions last an average of 1.5 years.
The National Bureau of Economic Research defines a recession as a significant decline in economic activity that lasts for more than a few months. This economic activity includes the number of employees on payroll, income levels, industrial production levels, and manufacturing or trade sales.
In terms of averages, the U.S. is overdue for a recession. From a stock market trading perspective, we’ve been in a bull market for over ten years.
The Most Likely Causes of an Economic Recession Coming in 2020
Other than the cyclical nature of the economy, the primary drivers of a recession coming in 2020 — and the means to prevent it — are three-fold: 1) the interest rates set by the Federal Reserve, 2) the U.S. Trade War with China, and 3) the health of the labor market.
1. Federal Interest Rates
In early 2018, the economy was doing so well that the Federal Reserve raised interest rates to the highest they’ve been since before the Great Recession of 2007. The surge in real estate flattened, slowing the housing market nationwide.
In 2019, the Federal Reserve cut lending rates three times in an attempt to boost the economy and provide insurance against political uncertainty and weakness in the global trade market. Cutting interest rates lowers barriers to loans, making it cheaper to borrow money and increasing the incentive to invest. In Q4, the Treasury Yield Curve has shown increasing signs of correction. If this trend continues, it might mean that a recession won’t happen in 2020 after all.
2. U.S. China Trade War
Around the same time that the Federal Reserve raised interest rates in 2018, the U.S. entered into a trade war with China. The Federal Reserve and other economists have cited the U.S. China Trade War as the primary cause for the economic slump in mid-2018 and a leading factor for a recession in 2020 or 2021.
3. The Labor Market
The labor market has been strong throughout 2018 and 2019, which has been a point on the side of naysayers who distrust the certainty of a recession coming in 2020 regardless of what is happening with trade.
A high unemployment rate is usually a solid indicator for a recession, and we’ve been hovering at a 50 year low of 3.5 percent, with the unemployment rate actually moving down 0.5 percent overall in 2019, indicative of a healthy labor market. However, the high rate of employment does not cover people across the U.S. — especially in the Midwest — who have stopped looking for work due to outsourcing overseas and permanent loss of jobs to robotics and automation
That being said, a strong labor market is a good indicator of a strong economy. A labor force at record lows for unemployment offers a counter argument to certainty that a recession is coming.
Preparing a Compensation Strategy When a Recession is Coming
As you can see, the state of the U.S. economy and the indicators for whether or not a recession is coming in 2020 are mixed, but in the last gasps of 2019, the outlook is brighter than it seemed just a few months ago.
We can’t know definitively whether a recession is coming or not in 2020. But whether it happens in 2020, 2021, or in subsequent years, a recession will come eventually. When it does, you should be armed with a proactive compensation plan designed to help you stay strong during the tough times and thrive in the long-term.
In a feature article on How to Survive a Recession and Thrive Afterward, the Harvard Business Review studied the factors that led some companies to thrive and others to fail following recessions in 1980, 1990, and 2000, and found that the biggest differentiator was preparation. Rather than reacting to a down economy by making deep cuts across the board, these companies approached the recession with a strategic plan and a flexible approach to managing change that would see them through to the other side and in a position to grow rapidly once the market turned around. Out of the findings, the most prominent and impactful actions that resulted in success were deleveraging debt, enabling decentralized decision making, taking a proactive approach to workforce management, and investing in digital transformation technology.
The section on proactive workforce management discusses how furloughs and hour reduction can be more profitable to companies in the long run than layoffs, especially in organizations where hiring the right people is time consuming and training is expensive. This is particularly true if your workforce is currently performing well. If you can’t justify a furlough or hour reduction, or if most of your employees are salaried, you can also look into performance pay, which means adjusting your compensation strategy to weigh more heavily toward incentive pay or bonuses to reward productivity and business outcomes rather than hours.
In other words, your compensation strategy is a critical part of recession planning.
Generally, strategies like making pay cuts across the board, laying off workers, suspending benefits, extending low-ball offers to new talent, and other cost-cutting measures to save money in the short term has a negative impact on the business in the long run. This is because these types of decisions are usually more reactive than strategic, could have been prevented if finances were managed better, and fail to account for the importance talent will always have to any business. The cost of turnover can be much higher than the savings enjoyed from temporary payroll relief.
If you don’t approach workforce management strategically, even during a recession, you risk losing the people who are most likely to keep your company afloat and make your business profitable.
When it comes to developing a comprehensive compensation strategy to weather a recession and thrive afterward, here are some recommendations:
1. Develop a Compensation Plan
Whether feast and famine, you need a strategic compensation plan based on up-to-date market data. Your compensation plan should be structured around the goals of your business and address whatever challenges you might be having currently or anticipate having during a recession. Structure your compensation strategy to produce the business results you want and make sure it’s competitive for a changing market.
2. Determine Pay Grades and Ranges
It’s important to use accurate data to develop benchmarks for salary ranges based on compensable factors like size of company, years of experience, location, and special skills. Small businesses are more at risk to lose talent than larger businesses during a recession so it’s even more important to get pay right in the SMB sector. You can use pay grades and ranges to determine whether current employees are being overpaid or underpaid and use this information to adjust compensation to retain talent.
3. Offer Performance-Based Incentive Pay
As mentioned, performance-based compensation can be an attractive option during a recession. With tight budgets and lots of candidates on the market, you can ensure you are only spending what a job is worth by making a larger part of your compensation package performance-based. Create an incentive pay plan based on the financial performance metrics, but make sure that the rewards are generous and enticing enough to retain good performers after the recession has ended.
4. Communicate Your Compensation Plan
Communication of your total rewards package is key, especially during a recession when money is tightly controlled, hours are longer, and employees are being asked to do more with less. Your employees are anxious about the future and morale is important. As long as your compensation plan is sensible and supported by accurate, verifiable data, communication around how and why compensation will change during a recession should net you more engagement and productivity from employees. Your objective should be to express gratitude for the hard work your employees are doing in difficult times, offer a sense of stability, and mollify fears to allow employees to focus on their jobs. Make sure you discuss the method of communication as well as the messenger. Managers should be informed of compensation changes before staff.
5. Improve Operations Before Cutting Staff
Before you resort to broad pay cuts or layoffs, take a look at your operations and see where you might first save money by boosting output or increasing efficiency. If recessions are good for anything, it’s forcing companies with ineffective practices out of business and rewarding companies who are able to manage well and innovate when times are hard. Make sure you reward innovation when you see it. If you are forced to resort to layoffs, try to avoid recurring or rolling layoffs and make sure you aren’t laying off protected groups in a manner that can’t be legally justified.
6. Revisit Benefits
During a recession, it’s common for employers to reduce benefits — especially fringe benefits like a company car, phone allowance, paid meals, educational assistance, and so on. Be careful not to take benefits cutting too far, but it’s worth the time to review what benefits may be considered more of a perk than a necessity and exploring how the elimination of extraneous or underutilized benefits may boost the bottom line in a difficult year. You can also introduce trade-offs. For example, if you have to give up 401K employer matching in order to afford payroll, perhaps you can swap in a recognition program or allow employees to work from home one day a week.
7. Consider Contractors
During a recession, many companies will rely more on contractors to complete projects and fill vacancies in teams rather than take on the risk of a full-time hire. An optimized outsourcing strategy can be cost effective and allow the organization to scale even when times are uncertain. Of course, it’s still important to retain full-time staff, especially people in decision-making roles or who are responsible for knowledge share or who are high performers in the organization. It’s also important to make sure that you are tracking how contractors are paid, both in comparison to each other and in comparison to full-time employees who are doing the same work.
8. Value Top Performers
The best people will always have choices. Don’t make the mistake of undervaluing top performers when the economy has taken a downturn. One of your most important assets is your sales team and the people who care for existing customers. If you manage a technology company, you are also going to want to retain the developers responsible for building and shipping your product. If you are in a position where you can only give raises to some of your staff, make sure you are using data to evaluate the top performers and doing what you can to retain those people.
Depending on your business, if a recession is coming, it might mean lost customers, an anemic pipeline, and layoffs. Whatever measures you have to take to stay in business during a recession, remember that recessions are temporary, lasting an average of 1.5 years. Once the market improves and profits begin to rise, you would be wise to revisit your compensation strategy to make sure you are fairly paying employees that stuck with you during the hard times. Always keep your focus on what happens next — the growth that is possible in an emerging bull market — and focus on what you need, and who, to maximize growth once the market turns around. Plan your compensation strategy accordingly.
How PayScale Can Help
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