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Why Wages Don’t Fall During a Recession

By: Steve Johnson

1/6/2009 - 68 Comments

A few weeks ago I was discussing this with a few of my friends and we couldn’t come up with a clear and decisive answer.

A few days ago, I found a great article about it on the personal finance blog, “Tough Money Love”.

The author makes the case that wage reductions are primarily not used because they result in a reduction in employee moral which leads to a drop in productivity. 

Here is what he says,

“I believe that the fundamental problem with using wage cutting instead of job cutting is that most American workers cannot psychologically handle the pain.  We are all about raises and bonuses, both to feed our consumerism and our egos.  We would view wage cuts less as a reasonable means to keep people employed and more as a direct attack on our individual self-esteem.

I think that employers have figured that out as well.  They know that wage cuts would be immediately followed by a significant drop in employee morale.  And this would not be a temporary drop.  Most employees would be unable to move beyond the blows to their ego triggered by a smaller paycheck.  Unhappiness would be followed by loss of productivity. “

The author also mentions that a recession given employers the opportunity to cut the fat and cut the higher paid workers while avoiding a claim of discrimination.  Here is what he says,

I also suspect that some employers view economic downturns as a good opportunity to get rid of problem employees without taking so much heat from those employees who remain.  The bad economy provides good cover for the decision.  By “problem” employees, I mean those that have bad attitudes, poor performance, or simply make too much money.  And by “make too much money” I am referring to laying off the older employees.  What better way to avoid a claim of age discrimination than to take action during recession?

I won’t name names, but in my first job out of college, I recall twice being called into a full-department meeting so that the department managers could tell us about how bad things were in our industry.  We were told that this meant that staff reductions were necessary.  All of us would then jerk our heads around rapidly, trying to identify the victims by who was missing.  It was always the older engineers.  I was glad no one asked me to reduce my salary to save their jobs.  But the bottom line is that I don’t think my employer had any interest in saving their jobs.  Better to replace them with younger engineers who made less money.

From my experience, this seems pretty accurate.  Based on this assessment, the employer has opportunity leverage over the employee’s during a recession.   The other side of the coin is the opportunity for the laid off employees to start their own business and compete against their previous employer.  When the economy improves, the new business could become a major competitor to the existing previous employer's business.  This risk needs to be considered when an employer started cutting jobs. 

Another Option

Another option that I have seen is to give workers the option to apply for new jobs within the company. Of course, these other jobs pay less money, but the lower pay can be adequately justified without losing moral or productivity because the position and tasks are slightly different.

This idea can be used to retain your best employees, while reducing their wages without losing productivity.  The only obstacle is having another department that is growing fast enough to justify hiring more employees.  But a growing business always needs a new market to go after, even if the profit is lower, moving employees around is a great way to go after new markets in a recession.

The opportunity to reduce the wages of your best employees can be just what you need to make the new market profitable to go after and provide a pathway to grow your business out of the recession, while reducing your risk of your employees starting their own business and competing with yours.  If your job in on the line, consider explaining this idea to your employer and encouraging them to go after a new market – even if it’s not as profitable in the current shrinking market - it could save your job.  If your employer doesn't go after new growth opportunities, someone else will.

The Book

Apparently this subject has created enough discussion for someone to write a book about it.  Truman F. Bewley wrote the book “Why Wages Don't Fall during a Recession” in 2002 to address this issue.

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