Sticky Wages

by Manshu on July 1, 2009

in Articles

In the 90’s Truman Bewley of Yale University interviewed thousands of employers and found that they preferred layoffs to wage cuts.

Companies who needed to cut costs preferred to save money by firing a few people rather than slashing salaries across the board.

This means that even though prices of oil, cars, vacations, toothpastes and chocolates go down in recessions, salaries don’t.

Nominal wages tend to stick around to their existing levels, and hence the term – sticky wages or wage stickiness.

So, sticky wages mean that salaries don’t fall in a recession, they just grow slower.

We were seeing this till a few months ago, when there were a lot of news stories of companies reducing their workforce and laying off people by the thousands. But, there were hardly any news stories of dramatic across the board pay cuts.

It is only recently that companies like FedEx, HP, New York Times and the state of California are asking workers to take a pay cut or mandatory unpaid leaves.

I am sure that a lot of you must have observed that companies prefer job cuts to pay cuts, so let’s take a look at the top reasons that contribute to sticky wages.

1. Employee Morale: Truman Bewley found out that pay-cuts affected everyone’s morale, while firings only affected the minority. I am sure all of you, who have seen layoffs agree that the people left behind, are much more productive than they were ever before.

When you see your colleague getting fired, you work extra hard to make sure that you are not next in line. Pay-cuts don’t have the same effect, as everyone is on the same boat, and there is no shock effect to spur employees.

2. Fear of the best people leaving: The job market has slowed down in the recession, but there are still plenty of firms that are hiring.

If an employer cuts salaries across the board, it is quite likely that the better workers will find work elsewhere. So, firms which implement across the board wage cuts, risk disgruntling their better employees and have them leave for greener pastures elsewhere. This factor is a major contributor to sticky wages.

3. Get rid of Wally: Not all employees are created equal; some are more efficient than others. In all companies there is some deadweight. Some of your employees will be like Dilbert, some like Alice and then you will have a Wally. If you kept Dilbert and Alice, and fired Wally – your team will still do well, if anything the overall productivity of your team will increase. Even the Pointy – Haired boss knows that it is far better for him to fire Wally, than to take a chance by cutting the salaries of Alice and Dilbert, and risk losing them to Elbonians.

4. Preparing for the turnaround: Another factor that contributes to sticky wages is the hope of a turnaround. I know several people who are hanging around in companies without any work or pay – cuts. While there isn’t much demand for their skills now; their employer doesn’t want to take a chance. The employer is worried that if they let this person go, the competitors will build a strong team in this particular area, and drive them out of business when the market eventually turns.

If you look at these factors, they are centered on productivity, morale and deeply tied into competition. An industry with fierce competitors, who are gunning to poach the rival staff, is more likely to have sticky wages, than an industry where all players are struggling for survival.

Have you seen sticky wages in your area of work? What do you think contributes to sticky wages?

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{ 5 comments… read them below or add one }

The Incidental Economist July 1, 2009 at 8:33 am

Sticky wages are one of the reasons economists favor some (small) amount of inflation. A way for firms to achieve a real wage cut without cutting nominal wages and suffering the problems you describe is to just to raise wages at a rate below inflation. This only works because in general people are ignorant about inflation, at least in the short- to medium-term and if the inflation rate is not too high. A 2% rate is the Fed target and the average person doesn’t notice that for a few years.

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Manshu July 1, 2009 at 6:34 pm

@TIE

I am just curious as to know if there are any examples of of economies going through deflationary pressures and still maintaining the same wage rate as before?

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vh July 8, 2009 at 7:52 am

Interesting post — nice, clear explanation of this issue.

At my (soon-to-be-former) workplace, we’ve seen wages fall steadily since last January from a combination of furlough days, weird tax increases that are not “really” tax increases (but that manage to bite into your take-home pay anyway), and various incomprehensible schemes whose net effect is to take income away from workers.

For example, last night my associate editor forwarded a message from HR informing her that when the administration switched her job status behind her back last March, without telling her (a strategy allowing them to fire her at will, instead of having to treat her fairly according to the employee manual’s rules), dreadful PeopleSoft failed to enroll her in the mandatory retirement plan, and so they’re going to gouge all the back payments out of her piddling salary at once. Since she earns less than she earned when she was a graduate assistant (!), this will mean her next paycheck will contain little or no pay.

My gross pay has dropped $500/month. My net has gone from $1537 to $1418 per paycheck, a net cut in pay of $240 a month.

Net effect on morale? Well, I’m being laid off in December, and to tell you the truth, I’ve come to hate my job and my employer so much that I’m seriously thinking of quitting forthwith. If I wait until September, COBRA will carry me through to Medicare — although it will cost me more, the savings in stress, annoyance, and outright fury will be considerable. When I walk, my entire office will shut down, since it’s unlikely the university can find anyone competent and willing do my arcane job for just a few months. I can’t wait to be out of that place…and that sentiment, alas, is shared by every single fellow worker I know.

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Manshu July 8, 2009 at 5:58 pm

VH: That’s an amazing story! Thanks for sharing.

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viwe August 19, 2010 at 2:56 am

good information

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