I hope that I am wrong, but…

I hope that I am wrong, but…

In the past few weeks a number of our firm's clients have asked me what our firm thinks about the economic outlook for the United States in 2011.

I have to be less than optimistic about 2011. As Paul Krugman pointed out in his column in yesterday's New York Times, the U.S. economy is still at "the bottom of the hole." We cannot mistake short-term upsurges as sustained recovery. Proclamations that "the Recession is over" are mostly political hyperbole. Fundamental structural weaknesses persist in the U.S. economy and there is no sign at any level of government or in the financial sector that they will be addressed soon.

I am most concerned about unemployment. We have witnessed the Florida county where our firm is headquartered plummet from being one of the most prosperous and economically robust areas in the country to being a poster child for hard times. Unemployment has gone from less than 5% in 2007 to over 12% now, while per capita income has dropped by more than 5%. Many of the jobs that have been lost have been in the construction and services sectors, and many of those jobs are probably gone forever as they have been triggered by business failures. This experience is being duplicated, to greater or lesser extent, almost everywhere in the United States.

These numbers might not appear alarming in some economies outside the United States, where 10% to 15% unemployment might be more common. Three factors make these numbers a concern for the long-term prospects of the U.S. economy:

  • The persistence of very long terms of unemployment, even more than 99 weeks
  • A weak social safety net, particularly in basic human needs and job retraining, which results in the long-term unemployed being pushed into poverty without the basic resources they will need to escape
  • The absence of what Paul Krugman calls "a rational political system" to deal effectively with any of it.

What concerns me the most is that we might be witnessing the final economic dismantling of a large part of the American middle class, which has always been the great engine of economic recovery in the United States.

In short, don't look for a sustained recovery in the U.S. in 2011 and maybe not even in 2012.  As Krugman points out, the U.S. economy is now so deep in the hole that it would require a sustained annual growth in GDP of 2.5% to start to reduce unemployment significantly and being to climb out; and even the most optimistic forecasts are nowhere near that threshold.  Moreover, this would need to be sustained growth, at least at that level, over many months, not just one quarter.

What does this mean for U.S. law firms?  We see several likely scenarios, which might vary according to a firm's client base and practice specialties:

  • Firms that depend heavily on the banking and finance sectors will see some short-term improvements, but most of these firms probably will not see robust, sustained growth in 2011. Things probably won't get worse, but they might not get substantially better.
  • M&A work in the U.S. will revive somewhat, particularly in the technology and retail banking, but clients will not be likely to as generous with fees as they were five years ago.
  • "Economic cleanup" work - i.e., restructurings, insolvency, and commercial litigation - will produce significant short-term improvements in fee revenue for many firms; but converting these into long-term, sustainable, and profitable client relationships will be challenging.
  • We expect to see a continuation of the interest in law firm mergers, particularly in the tier of law firms just below the acknowledged market leaders.  The motivation for much of this interest will be defensive, i.e., to reduce operating costs, strengthen client bases in key sectors, and hold market position against the top tier firms. This could also produce some interesting opportunities for foreign firms to establish a presence in the United States.
  • We are already observing a heightened interest inside law firms in partner performance and compensation , associate productivity, and the profitability of the firm's internal operations.  Some of these issues have been avoided in the past, either because they were not at a critical level or because they were too sensitive to discuss.  That has changed.

I hope that I am wrong, and that 2011 will be a good year for law firms in the United States.  Even if the short-term results for some firms appear promising, American law firms should avoid the temptation to assume that "Happy Days Are Here Again."  2011 will be a year to celebrate short-term successes, to be sure, but also a time to investigate and strengthen the basic business foundations of the law firm.

Read more on the Walker Clark Worldview Blog.