What hurts morale the most is when layoffs affect teams and people who are clearly not "underperforming". I've seen some star devs getting swiped up into mass layoffs, and that is incredibly demoralizing because it hammers home the point that it doesn't actually matter how good you are at your job, how much esteem you have with colleagues etc. Not even your manager will be able to help you if the entire team gets canned.
When your choice is basically having someone incompetent on the team vs not having the guys who carry it the most, I think most people will take the former. Incompetence can be managed to minimize damage, but there's no substitute for lack of competent people.
Fully agree with you on the impact of firing competent people. I think you severely underestimate the impact of not firing or even promoting the incompetent or the zero or negative contributers.
When your choice is basically having someone incompetent on the team vs not having the guys who carry it the most, I think most people will take the former. Incompetence can be managed to minimize damage, but there's no substitute for lack of competent people.