What no one says (but everyone recognizes) is that recessions are a grim sort of industrial policy. They promote efficiency and punish sloppiness. The deep downturn of the early 1980s helped rehabilitate U.S. manufacturing. Old plants were shut, and survivors streamlined. Now, a wide swath of the service sector may undergo a similarly shattering upheaval.

It’s already starting. The airline and banking industries are in the throes of major consolidations. Eastern Airlines has vanished, and Pan Am is about to go. Chemical Bank and Manufacturers Hanover are merging; likewise, NCNB in Charlotte, N.C., and C&S/Sovran in Atlanta are combining. But these mergers and industry consolidations only symbolize the pervasive cost pressures that are squeezing service businesses–from accounting to advertising–that grew bloated in the 1980s.

This is a bad news-good news story: bad for the victims of layoffs and bankruptcies; but good for the economy. To grasp why, consider the service sector’s size. Broadly defined, it constitutes about half of the economy. However, its growth in productivity (output per hour worked) is virtually nil. Between 1980 and 1990, annal gain averaged a paltry 0.2 percent. By contrast manufacturing productivity has risen a healthy 3.5 percent a year since 1980. In plain language, most service industries didn’t become more efficient.

We ultimately consume what we produce, and unless services do better, living standards won’t rise much. The manufacturing sector is simply too small (about a fifth of the economy’s output) to lift living standards rapidly. In a broad sense, what’s at stake also includes better environmental production, more government services and more leisure. Higher productivity creates extra resources and time for everything. Finally, the dismal performance of the service sector has fostered inflation. Since 1982, service prices have risen 5.2 percent annually, compared with 3.1 percent for food and manufactured goods.

By standard measures, the 1990-91 recession has been mild (table). It lasted about half a year. In the second quarter, growth resumed with gross national product expanding 0.4 percent at an annual rate. But the distress of the service sector stems less from the recession’s severity than from overexpansion during the 1980s. Many companies were actually becoming less efficient as the decade wore on. Look, again, at the productivity statistics. Between 1980 and 1986, service-sector productivity increased a modest 0.6 percent annually. But between 1986 and 1990, productivity dropped 0.5 percent annually.

The building boom is a big part of the problem. Overlending for construction projects–office buildings, shopping malls, hotels–has savaged many big banks and depleted the ranks of developers. It has also undermined retail chains and hotels; too many stores are chasing too few sales, too many hotels are chasing too few guests. In the 1980s, the amount of shopping-center space jumped 52 percent, to 4.5 billion square feet, reports analyst Robert Buchanan of Alex. Brown & Sons. Some companies piled up huge debts. “There was an assumption that the good times were going to last forever,” says Rick Gallagher, editor of Stores magazine.

What’s occurring now is a reaction to these excesses. It’s survival of the fittest. Ultimately, though, the shakeout may enhance productivity in three ways:

Consolidation creates economies of scale: Fewer banks, airlines and retail chains will share the business. The building boom is over. This means fewer ne stores, office buildings and hotel rooms. More rooms at existing hotels will be occupied, sales at existing stores will rise and, yes, even the office vacancy rate (now about 20 percent) will someday decline.

Companies that survive are typically more efficient than those that don’t. Take airlines. “Almost all the airlines that have failed had extremely old fleets,” says Lee Howard of Airline Economics Inc., a consulting company. “They cost a lot more to maintain. They were not nearly as fuel efficient as newer planes.” Or take retailing. Wal-Mart, now the largest chain, is still expanding. But its sales per square foot are more than 50 percent higher than the industry average, according to Buchanan.

Squeezed profits cause even surviving companies to revamp their operations: consider the securities industry, which started to cut back after the 1987 stock-market crash. Few firms failed (Drexel Burnham was the biggest), but employment has now declined a fifth. Companies have left marginal lines of business.

The same sort of process, of course, is still occurring in some manufacturing industries, especially those that overexpanded. Computers provide the best example. Last week Digital Equipment and Unisys announced further cost reductions that could reduce employment at each company by about 10,000.

What looms is a messy recovery. The shakeouts will continue. There’s no boom in sight to rescue weak firms, and strong firms will have to improve profits through cost-cutting. Indeed, expectations of a modest recovery will intensify the pressures. Some economists predict a “double dip” recession. The typical forecast anticipates only slow growth. The National Association of Manufacturers, for example, projects an annual growth rate of almost 3 percent over the next 18 months. The unemployment rate (7 percent in June) would drop to 6.4 percent by the end of 1992.

But a messy recovery is not automatically bad. If companies increase wages and profits through higher productivity, the rebound would feed on itself. Inflation would remain subdued by moving decisively below 4 percent. (It was 6.1 percent in 1990 and has been running at a 2.7 percent annual rate this year. The recent decline, however, mostly reflects falling oil prices.) Lower inflation would raise consumers’ purchasing power and probably cause longterm interest rates to drop. That, says economist Lawrence Kudlow of Bear, Stearns & Co., would be a “monetary tax cut.”

What are the odds of this? No one knows. If it happens, the recession will have its silver lining. If not, the slump will simply have been a stop on the road to stagnation.

While some economists predict a slow rebound and even a second recession, the 1990-91 downturn was tame compared with the eight other postwar slumps.

CHANGE DURING RECESSION INDICATOR 1990-91* AVERAGE Real Gross National Product -1.1% -2.6% Civilian Unemployment Rate** +1.7 +3.0 Industrial Production -5.0% -8.9%

  • CHANGES FROM THIRD QUARTER 1990 TO FIRST QUARTER 1991 FOR REAL GNP ** IN PERCENTAGE POINTS