Governments, like the private sector, need to assess the financial costs and benefits of a work force restructuring program. Unlike the private sector, however, governments also need to assess a program's economic costs and benefits to society, or the economy, as a whole. The key questions and potential tools of analysis are summarized in table 7.1.
As outlined in module 1, the immediate triggers for work force restructuring are often financial crisis, not economic crisis. In such cases the financial analysis can be a more critical question for government than is economic analysis.
| Question | Tool |
|---|---|
How much will the program cost? |
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What are the financial benefits? (How much money will government save?) |
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How can the program be funded? |
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How long will the program take to pay for itself? |
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What is the financial impact of different approaches to selection and work force restructuring? |
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Looking at the economy as a whole, do the economic benefits of work force restructuring exceed its costs? |
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Table 7.2 provides a checklist of potential financial costs that may be incurred and that must be included when assessing financial returns. Essentially, the following equation captures the situation:
Financial costs = SC + RC + FC + CC + JC + TC + UC
Work force restructuring often uses batches of workers over time. The costs (and benefits) of future batches need to be discounted to a common present value.
where SC is the present value of severance costs, RC is the current net value of retirement costs, FC is the existing value of transportation for worker and family, CC is the cost of counseling, JC is the cost of job-search assistance, TC is the cost of training, and UC is the present estimated value of unemployment benefit and other social payments,
When collating those costs the implementing agency will need to ensure that:
Financial benefits should also be considered in the context of government as a whole, not just of the infrastructure enterprise.
| Item | Comments and examples |
|---|---|
| Direct costs of separation | |
Present value of severance costs (SC) |
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Net present value of retirement costs (RC) |
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Present value of transportation for worker and family (FC) |
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| Redeployment costs | |
Counseling (CC) |
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Job-search assistance (JC) |
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Training (TC) |
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| Other costs | |
Present value of estimated additional unemployment benefit and other social payments (UC) |
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Table 7.3 summarizes sources of benefits from a labor program, as portrayed by the following equation:
Financial benefits = W + R + B + O + P
where W is the present value of wage savings, R is the current net value of retirement benefits saved, B is the present value of savings in kind (nonwage allowances and other benefits), O is the current value of reduced operating costs, and P is the estimated increase in PPI transaction proceeds resulting from the labor force adjustment.
As with costs, benefits should be assessed in the context of overall government spending. If an enterprise gains cost savings as a result of the transfer of staff to another enterprise or elsewhere in government, then overall there is no cost saving to government (as in the example of the transfer of Aqaba rail employees to the Jordan Phosphate Mines Company, described in module 4, box 4.6). The pension analysis similarly needs to consider the whole government context. If pension costs are merely transferred from the enterprise to another publicly guaranteed scheme, then there may be no cost saving for government.
| Item | Comments and examples |
|---|---|
| Direct benefits of separation | |
Present value of wage savings (W) |
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Net present value of savings in retirement benefits (R) |
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Present value of savings on benefits in kind-both variable and semivariable (B) |
These benefits can include but are not limited to:
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| Other benefits | |
Present value of reduced operating costs (O) |
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Estimated increase in PPI transaction proceeds as a result of work force restructuring (P) |
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Most benefits are self-evident, but pensions can be complex. In a defined-benefit plan with a high ratio of pensioners (receiving pensions from the plan) to employees (contributing to the plan), a large number of departures could tip the plan into financial insolvency. Complexity can also arise if different workers within enterprises have different pension programs. To illustrate, if some workers are public servants and others are enterprise workers subject to a general labor code, net savings to government might be higher for retrenchment of the public servants because they have more generous pension benefits.
The simplest costbenefit analysis that the implementing agency can make is an undiscounted financial payback.
Where the costs of work force restructuring are wholly front-loaded, the simplest method of analysis that could be considered is undiscounted payback (or breakeven) analysis. In the example presented below, an initial expenditure of $100,000 in severance payments is "paid back" by the end of year 4 as a result of annual savings (wages and other staff costs) of $25,000. The simple payback (or breakeven) period is calculated as the number of years it takes for the wage bill savings to equal the financial costs-in this case 4 years.
| Year | Work force restructuring costs ($) |
Cash savings ($) |
Net cash flow ($) |
|---|---|---|---|
| 0 | 100,000 | -100,000 | |
| 1 | 25,000 | -75,000 | |
| 2 | 25,000 | -50,000 | |
| 3 | 25,000 | -25,000 | |
| 4 | 25,000 | 0 | |
| 5 | 25,000 | 25,000 | |
| 6 | 25,000 | 50,000 |
The introduction of discounting in the above example gives a more accurate picture of the payback period. By taking into account the lesser value of money tomorrow instead of today and assuming an annual discount rate of, say, 10 percent, the initial expenditure of $100,000 is paid back not at the end of year 4 but during the course of year 5.
Most evaluations of work force restructuring programs reveal very fast payback periods.
| Year | Word force restr- ucturing costs |
Cash savings |
Present value factor |
Discoun- ted values at 10% ($) |
Net Net flow ($) |
|---|---|---|---|---|---|
| 0 | 100,000 | 1.000 | 100,000 | -100,000 | |
| 1 | 25,000 | 0.909 | 22,725 | -77,275 | |
| 2 | 25,000 | 0.826 | 20,650 | -56,625 | |
| 3 | 25,000 | 0.751 | 18,775 | -37,850 | |
| 4 | 25,000 | 0.683 | 17,075 | -20,775 | |
| 5 | 25,000 | 0.621 | 15,525 | -5,250 | |
| 6 | 25,000 | 0.564 | 14,000 | 88,850 |
The payback period is calculated on the basis of the fraction of year 5 needed to bring net cash flow to zero. In this case:
Payback = 5 -(-5,250/25,000) = 5.21
Some Results of Payback Analyses
In a survey of work force restructuring programs in six countries, Svejnar and Terrell (1991) found that payback periods varied from just four months to 4.7 years. Haltiwanger and Singh (1999) evaluated the financial returns of 41 downsizing operations based on World Bank internal documents for a range of civil service and state enterprise retrenchment programs. Their evaluation included a discounted financial payback method, which assumed a 10 percent annual discount rate. For the 24 operations with sufficient information to calculate payback analyses, their results can be summarized as follows:
These findings are striking. On the one hand, many labor programs appear to offer exceptionally good rates of return. Few investment projects display such high financial returns as the 15 cases mentioned. Other programs, however, have not recovered their cost, often because of the problems of adverse selection and rehiring described in module 5.
Many people would object to the idea that downsizing can be seen as a "productive" investment, but work force restructuring can be analyzed using the normal tools of investment appraisal.
Work force restructuring can be viewed as a project. Classic investment projects are based on an (often high) initial capital investment, followed by a stream of positive cash flows arising over a number of years. Those positive cash flows are derived from productivity improvements that lead to higher revenues or greater savings. Work force restructuring shares a similar pattern, so the tools of investment analysis can be applied equally well to a work force restructuring project as to a capital investment project. (A sample spreadsheet is presented on the CD-ROM.)
Sample spreadsheet for analysis of labor projects.
Where work force restructuring involves significant downsizing, it is difficult to persuade some to see this as a "productive" investment. Downsizing is productive, however, in the sense that it removes and reallocates unproductive labor to more productive activities elsewhere. It increases labor (and often total factor) productivity within the enterprise. Where there is a genuine surplus within the work force, the jobs are not "real" jobs, and surplus workers' marginal productivity within the enterprise is likely to be close to zero. Their expected productivity will be greater in other employment or other activities outside the enterprise.
When using discounted cash flow analysis techniques for labor adjustment, the implementing agency should check that:
Three main indicators for cost-benefit analysis are:
In complex activities, such as work force restructuring, a single number-be it IRR, NPV, or BCR-is unlikely to be enough for informed decisionmakers. Sensitivity analysis shows how variations in the key assumptions underlying the analysis influence the expected outcomes of the restructuring program. At its simplest, this means running a spreadsheet model under different assumptions and presenting these variations in a table.
