17 Feb 2016

Fire workers to stop the fall in oil prices?

Rocio writes*

The price of oil has been declining steadily over the last few months. Since November, the price of oil has decreased by 40 percent, as represented below by Figure 1. This has impacted all sectors of the economy. When the price of oils falls, it causes oil companies such as Shell to generate less profit, which dissatisfies the demands of their shareholders. The CEO is then left in charge to come up with a reaction to this unforeseeable event. Recently, the Royal Dutch Shell PLC (RDS-B) has announced that it will fire 10,000 workers due to the falling oil prices in order to “bolster margins.”

A firm’s total cost is made up of variable costs and fixed costs. Decreasing the number of workers in a firm, is seen as a way to reduce costs, as it is a variable cost (a cost that either increases or decreases depending on the firm's’ production). A firm can only decrease total costs, in the short term, by reducing its variable costs.

Reducing the number workers in a firm is intended to lower costs, however at times, the result can be more negative than positive. It can create a lower morale and distrust in the company, due to the remaining workers fearing the loss of their own jobs. Cutting down on workers also affects the production capabilities of such company which may, in fact, be counterproductive to the firm’s aim of increasing profit as it puts more pressure on the remaining workers.

One thing that Shell could have been done instead of laying off thousands of workers is reducing everyone’s salaries temporarily, as to account for the change in oil price. This exact same thing was done by the Canadian Natural Resources based in Calgary where all workers kept their jobs but everyone’s wages were trimmed.

Bottom Line Firing workers will reduce variable costs, but there are other ways to reduce labour costs. Decreasing every worker’s salaries would have worked as well and would have ensured that the production within the firm stayed the same as there would be no extra pressure put on workers and the fear of losing their own jobs would be reduced if not eliminated.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.