In praise of cost cutting

In praise of cost cutting

David Surdam /

Major American airlines are notorious for squeezing more passengers onto their planes. The image of sardines in a can is apt. Passengers, of course, whine. Pundits, consumer advocates, and legislators are outraged and claim airlines are only interested in increasing profits. Is it ethical to reduce costs or to increase revenues in order to increase profits?

Economists can shed light on this situation. Many ethicists lack training in economics and may misunderstand some of the nuances involved.

Taking an extreme case, a profit-maximizing monopolist who finds a way to cut her marginal costs will benefit consumers by reducing prices and selling more units. An economist can easily demonstrate this result with a supply and demand-style diagram. This presupposes that consumers voluntarily purchase the monopolist’s good or service. In some cases, governments mandate that consumers purchase a good or service (motorcycle helmets and automobile liability insurance are examples). In these cases, monopolists may not cut their prices after reducing costs.

The monopolist who reduces her marginal costs will, indeed, increase her profits. This is a good outcome, as it spurs monopolists to find ways to curb costs, thereby freeing resources for other uses. None of us should want monopolists to behave in a slovenly fashion.

I’ll admit that I have a greater tolerance for cramming more people onto passenger planes. I’m a relatively small person, so legroom and seat width are of less concern to me than my colleague down the hall, who is 6’5” and 240 lbs. The cramming undoubtedly leaves him less comfortable.

There is a limit to airline cramming, aside from government fiat. Airlines understand that passenger discomfort has limits before customers seek alternative means of transportation. A rival airline might opt to provide more legroom and wider seats in order to entice customers away from the airline with cramped seating. Airlines have also created premium seating for people willing (and able) to pay more for greater comfort.

In general, American industrial titans such as John D. Rockefeller and Andrew Carnegie understood that controlling costs while improving quality were winning strategies. They gained market share by paying attention to details and emphasizing quality. Rockefeller succeeded in reducing the price of high-quality kerosene (the main product for oil back in the late nineteenth century), benefiting consumers by making illumination cheaper. Rockefeller and Carnegie also made mind-boggling amounts of profits. They never quite attained monopoly status, because of competition from rival American and international firms. In fact, both men scrambled to stay ahead of their competitors. They understood that complacency was disastrous.

Cutting costs by reducing the amount of labor is usually socially beneficial, as the displaced workers often—but not always—are re-deployed to more productive endeavors. Would we really have wanted to protect chimney sweepers or blacksmiths in the late nineteenth century, as demand for their services diminished?

The ethical aspect of cutting costs, especially with regard to labor, may lie in what responsibilities employers owe displaced workers. Few workers are ever guaranteed lifetime employment, nor would doing so be particularly desirable from society’s perspective. Employers may have duties to provide palliatives such as reasonable advance notice of layoffs and offers to help re-train or to place workers in new jobs. There are, sadly, workers who find it difficult to adjust. Perhaps they are relatively close to retirement and investing in new skills will not pay off.

Americans are fortunate that our economic system, imperfect though it be, encourages people to produce goods and services at low costs that people want or need. They have succeeded in providing us a higher standard of living than our ancestors enjoyed.

The views and opinions expressed are those of the author and do not imply endorsement by the University of Northern Iowa.