Key takeaways
- A recession is a slowdown in the economy and includes higher unemployment rates.
- Companies lay off workers to survive an economic downturn until sales will reliably grow again, and tech companies are always among the first to lose value and respond with layoffs.
- Other leading and lagging indicators help determine whether the economy is in a recession.
When there is talk of a recession, many people wonder if a recession or layoffs happen first, with so many factors are at play.
Here is what you need to know to understand the connection points between recessions and job losses better.
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What is a recession?
A recession is an economic environment primarily marked by prolonged losses in the gross domestic product (GDP), employment rate, retail sales, and industrial output.
The National Bureau of Economic Research (NBER) is the agency charged with calling a recession, but the NBER states that it does not use the aforementioned data points as absolutes. Instead, it looks at multiple data points and other inputs to determine when and where a recession occurs.
The NBER also calls a recession after it's begun because the data doesn't show up for at least a month after the economy has entered into a recessionary period.
Recessions happen regularly, but they're sometimes insignificant and don't last long enough to be noticed or remarked upon in-depth. One example is the recession of 2020 in the months following the beginning of the COVID-19 pandemic.
In February 2020, one month before the pandemic took hold in the U.S., the NBER noted that the country had the most prolonged period of uninterrupted growth in its history.
The country’s 128-month period of growth ended that February and lasted a total of two months before the economy recovered and returned to a growth phase. However, the NBER didn't make its statement until July 2021.
Industries that are sensitive to recessionary pressures make cuts in their workforce and lower output to compensate for reduced demand for products and services. They also cut spending in other ways, like closing physical locations, to maintain profitability and stay in business.
Why companies lay off workers
The number one cost of almost every business is labor. When a company starts losing its profitability, it looks for areas where it can cut costs, and labor is almost always at the top of the list for cutting.
Laying off employees relieves the business of its payroll burden and frees up cash. This makes the company look more profitable than it did previously.
Also, some companies are forced to lay off workers to survive when poor economic times arise. If a company is struggling to turn a profit when sales are high and a recession hits, chances are sales will decline. This will cause the business to lose a lot of money.
To lessen these losses, the company lays off some of its workforce to save money until the economy improves.
Generally, companies lay off many employees at once to reduce labor costs and boost profitability for the next quarter. They'll also institute hiring freezes for a set period to keep their profits higher while relying on the remaining employees to pick up the slack.
Other reasons companies lay off their workers include redundancies, outsourcing roles, and relocating the company to a new location.
So, which comes first, the recession or the layoffs?
This question is hard to answer because it can happen simultaneously. Typically, there will be an underlying event that causes consumers to pull back on their spending. When this happens, business profits decline, and some companies will resort to laying off workers.
The initial pullback in spending could be such that the economy experiences negative growth in gross domestic product, which is one of the main ways the NBER determines if a recession is present.
However, this data won't present itself until a few months later. During this time, unemployment reports will show an increase in layoffs, making it seem like these preceded the recession when, in reality, they occurred simultaneously.
Unemployment rate is a lagging indicator
A lagging indicator is an economic data point or factor that shows up at the end of a given period as opposed to the beginning or during the period. Unemployment is measured month-to-month, with the total employment rate coming at the end of the month, hence it is a lagging indicator.
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In other words, organizations such as the ADP and the Bureau of Labor Statistics collect the information throughout the month, collate the data into various buckets, and release the information to the public the following month.
The unemployment rate is a lagging indicator because the slowdown in the economy has already begun, and companies are responding to this by reducing their workforce.
The need to use leading and lagging indicators
Leading and lagging indicators help economists and analysts determine the current state of the economy and where it's heading.
A leading indicator is used to predict future economic events. However, these are not always reliable since it's not easy to say with certainty that growth or other positive signs will sustain over time.
Some leading indicators include initial jobless claims, the yield curve, the stock market, and durable goods orders.
Lagging indicators confirm or refute the predictions made at the start of a given period. They tell the individuals in charge whether or not their decisions were correct.
These indicators also help those in charge make better decisions in the future, learn from their mistakes, and improve outcomes. Other lagging indicators include consumer confidence and the Dow Jones Transportation Average.
Leading and lagging indicators can also help investors manage their portfolios better. However, if the unpredictability of our current economy has you feeling uncertain about your investments, Q.ai can help take the guesswork out of investing.
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The bottom line
It is difficult to say if a recession or layoffs come first because they tend to happen around the same time. However, because of the timing of data releases, it can seem as though layoffs come first.
That said, just because a few companies are laying off workers does not always indicate the economy is in a recession. Other data needs to be analyzed to reach that conclusion.
This is why paying attention to leading and lagging indicators is essential. They will give you a better sense of if and when the economy enters a recession.
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