Failure to elucidate (or the intended obscuring) of unseen policy costs and benefits is the kind of stuff that sends economists to an early retirement. The most common example is the unrealized gains from potential trade that haunt any and all forms of protectionism, but I often find more “micro” examples easier to convince an audience of because it allows them to delve into their own lived experience for supporting evidence.
I’m a big fan of this conversation with co-founder Reed Hastings about severance package generosity at Netflix. The interviewer is absolutely baffled that they offer a minimum of 4 months severance for all employees, with 100% pay and benefits, immediately after hiring, and it grows with length of tenure after that. How could a company afford such a costly line item, particularly one that yields no benefits at all? It’s exactly the kind of policy a central casting stereotype of an MBA would never consider or, perhaps more telling, would be the first on the chopping block when cutting costs to pump up quarterly earning numbers.
What Hastings lays out, besides just the warm-glow benefits of a more “compassionate” severance policy, is the subtle efficiency at the margin. The people making the decision to lay off an employee are sympathetic, pro-social, perfectly normal human beings. They don’t want to hurt someone else which means, perhaps even selfishly, they will take a series of costly intermediate steps to delay the prospective firing of a poorly matched or unproductive employee. The manager will incur costs that perhaps signal to the employee that they are inherently valued, that they, the manager and the company, want the employee to succeed, that any eventually possible firing is only an action of last resort. These actions, as anyone who’s ever had a job will know, rarely if ever succeed in reorienting the employee to a new and fruitful line of productivity. Rather, they simply delay their eventual firing, leaving them in the lurch to find new employment. The costs incurred to soften the impact of the inevitable firing are internalized as benefits by neither the employee nor the firm.
The more efficient policy, to the benefit of everyone involved, is to make the employment separation as early as possible, rolling over as much of those saved costs into a (nearly) pure cash severance that will soften their landing and subsidize their search for their next job. In anything less than the weakest job market four months is enough time to not just find a job, but to be selective in that search. Extended severance strengthens the bargaining power of the former employee in their job search because they don’t have to say yes to the first offer.
From the employer side, they can rest easy knowing that because their managers will not have to incur the emotional cost of wrecking their employees lives with cold calculating decisions to leave in employees in the lurch with 2 weeks pay and a “good luck” out the door, managers will, in turn, make employment decisions faster and more decisively. Generous severance pay is a perfect example of an excellent policy that only looks inefficient to those naive to the actual decisions being made on the ground. Conversely, a more draconian policy carries the pretense of a colder efficiency, when the reality is a flailing hodgepodge of spinning wheels and sundry transaction costs.
What other policies, micro or macro, might see their efficiency aspirations and denunciations wholly inverted if we were to consider not just their line item magnitudes on a spreadsheet, but the whole of their of interconnected costs and benefits?
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