Like many long-standing economic relationships, wage stickiness is being tested by the savagery of the recession. Ordinarily, when unemployment shoots up wages do not tend to fall: they simply grow more slowly. Why the price of labour responds less to demand than that of other commodities is a bit of a puzzle. In the 1990s Truman Bewley of Yale University interviewed hundreds of employers and discovered that, faced with a slump in demand, they would rather lay some workers off than cut the pay or hours of everybody. The sackings devastated those directly affected, but broad cuts to pay and hours hurt everybodys morale. The main drawback of pay cuts is that they fill the air with disappointment and an impression of breach of promise, which dissolve the glue holding the organisation together, he wrote in 1997.
In this recession hard-pressed employers are not just laying off workers but cutting wages and implementing furloughsunpaid, compulsory time off. A survey by YouGov for The Economist this week found 5% of respondents had taken a furlough this year and 13% had taken a pay cut. Watson Wyatt Worldwide, a human-resources consultancy, says the proportion of American employers implementing either wage cuts or furloughs has risen sharply since October (see chart 1). Since September, as unemployment has jumped three percentage points, the average work week has shrunk (see chart 2) and hourly wage growth has slowed sharply to 3.1%. The slowing will be even sharper once a big fall in bonuses, especially in the finance industry, is included.
Higher inflation in the early 1980s and 1990s meant employers could simply freeze wages or raise them more slowly than prices to achieve real cuts in pay. This still dented employees standard of living but without the humiliation of a smaller paycheck. Now inflation is lower (in fact, negative because of a big drop in fuel costs). So, in the absence of big increases in productivity, wage cuts may be less avoidable. With households carrying big debts, falling incomes could heighten financial stress and, at worst, initiate a cycle of wage and price deflation.
Bewley also found that psychological resistance to pay cuts melts when the employers survival is at stake. In January 40,000 members of the Teamsters Union agreed to a 10% cut by YRC Worldwide, a trucking company, which is at risk of bankruptcy. The company needs some help, a Teamster official said at the time.
Newspapers are also under severe pressure. The New York Times recently cut salaries temporarily by 5% in exchange for 10 additional days of leave. On June 23 it reached an agreement with a union representing employees of the Boston Globe on a 6% pay cut. Employees had earlier voted against an 8% pay cut, but gave in when the Times threatened a 23% cut.
When the Plain Dealer first said this year it needed to reduce its labour costs by $5m, the newsroom was furious. For years the journalists had got by with wage increases of barely 1%, after higher health-care and pension contributions were subtracted. But the wave of closures and lay-offs throughout the industry was sobering. Last year 27 newsroom employees were laid off and only two have since found full-time work. People are a little pale thinking about how to make their personal finances work [but] we are ahead of what we were earning if we all had to find new work, says Karen Long, the books editor and a union negotiator. The 12% pay cut consists of an 8% cut in pay rates plus 11 furlough days. If the company lays anyone off after the one-year agreement, pay automatically jumps back to its previous level.
In a society known for competitive individualism, pay cuts and furloughs are calling forth a spirit of collectivism. Hewlett-Packard, Advanced Micro Devices and FedEx have trimmed rank-and-file pay, but their chief executives have taken 20% pay cuts, says Challenger, Gray and Christmas, an outplacement consultancy. Slumping tax collections forced city administrators in Lima, Ohio, to draw up contingencies for a 10% cut in hours for all but emergency workers. But first the citys eight most senior administrators gave up a 2.5% pay rise.
All together, for the moment Not all such negotiations are being welcomed, however. In California home-care workers, who look after the infirm in their own houses, have demonstrated against Governor Arnold Schwarzeneggers proposal to cut their pay to the state minimum wage of $8 per hour. Their pay has already been reduced to $9.50 an hour from between $10 and $12 according to UDW Home Care Providers Union, one of their unions. To take another example: when the restaurant where Sandy Jaffe is a waitress near Los Angeles cut everyones hours in half because of slumping business, she was annoyed management didnt trim the hours of less productive staff more.
Still, most Americans seem to be responding stoically. Signs that the recession is bottoming out means the pressure for more cuts is ebbing: this week, a report from the OECD suggested that growth in the rich countries could resume next year, albeit at an anaemic 0.7%.
Although no one is happy to have their pay cut, many seem to like a brief break from the rat race. Some employers forbid employees to do anything even work related on their furloughs, such as checking voicemail or BlackBerrys. In some circumstances that could require the employer to pay the employee for the whole week.
When the teachers pension plan that Susan Daniel works for in California decided to furlough employees for two days each month, she welcomed the chance to spend the days at home with her husband and to get around to rebuilding the backyard deck. To cut costs, she gave up bottled water and her cable-TV service. The fact that everyone, including her boss, is getting the same treatment makes it much more bearable. At least we have our jobs and our benefits, she says.
The Economist Newspaper Limited 2009