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Take a pay cut to save jobs? No thanks.

Wage cuts are even worse for morale than layoffs


 

Take a pay cut to save jobs? No thanks.

When President Barack Obama made his inaugural address to the world last week, he included an explicit appeal to the virtue of generosity and sacrifice to help restore the economy to health. It is “the selflessness of workers who would rather cut their hours than see a friend lose their job which sees us through our darkest hours,” he said.

The message was particularly potent in light of our current economic doldrums. The awful toll of layoff notices continues to mount across North America and around the world. Over two million Americans have lost their jobs since this recession began and last week, within 48 hours of Obama’s stirring address, Microsoft, Intel and IBM revealed plans to cut thousands more. In Canada, layoffs topped 100,000 in November and December alone.

In this environment, it seems only sensible that companies and workers should be looking for any way to escape the self-feeding spiral of job cuts. Rather than cutting 10 per cent of its workforce, why wouldn’t a company instead offer to temporarily roll back wages by 10 per cent? And given that option, why wouldn’t workers enthusiastically embrace it? Back in the mid-1980s, MIT professor Martin Weitzman released a groundbreaking book called The Share Economy in which he argued that recessions would be shorter and less devastating if companies and workers agreed to raise wages in the good times, and to trim them back in lean years, reducing the boombust cycle of the job market.

This would save companies millions in severance costs, shore up consumer confidence and ward off the threat of stagflation—in which economic growth stalls, even as prices rise. And yet, the idea simply hasn’t taken off. So far, there has been only one high-profile example of a major employer, trucking company YRC Worldwide, instituting a 10 per cent wage rollback to avoid layoffs. A few months ago, Ireland’s minister of finance called on that country’s civil servants to volunteer for a temporary 10 per cent pay cut, in order to ease the fiscal strain on the public purse and to avoid public sector job cuts. As of last week, exactly 25 of the country’s 373,000 civil servants had stepped forward to accept the wage reduction.

This same pattern is playing itself out throughout the economy. The human resources firm Watson Wyatt recently surveyed U.S. businesses and found just six per cent are planning pay cuts, whereas close to 34 per cent expect to slash jobs this year. When cost cuts are needed, the vast majority of businesses still opt for the axe over the scalpel.

If there’s one industry where you’d think a little wage elasticity would be welcome, it’s the auto sector. It’s frequently said that a key problem for the North American carmakers is the fact that, even after the concessions made in the last round of contract talks, they have substantially higher labour costs than their foreign-based rivals. Still, both the United Auto Workers and Canadian Auto Workers have steadfastly rejected the idea that wage rollbacks might be part of Detroit’s solution. More surprising is the fact that GM isn’t pressing the issue. Just last week, GM’s chief operating officer said its efforts to trim costs would not include a wage rollback for its factory workers. GM, Chrysler and Ford are expected to shed close to 30,000 employees this year, and yet pay cuts are not even on the table. What gives?

The answers to this riddle can be found in a little-known 1999 book by Yale University economist Truman Bewley, fittingly titled Why Wages Don’t Fall During Recessions. The author interviewed more than 300 executives, union leaders, recruiters and HR experts in an attempt to unravel the mystery of why companies consistently opt for the expensive and complicated exercise of severing workers, rather than negotiating lower salaries.

The conventional wisdom, Bewley points out, is that unions are the prime obstacle to negotiated pay cuts. Unions exist primarily to defend the rights and interests of senior workers, and since those more-established workers tend to make the most money, and layoffs generally target newer arrivals, they are far more willing to countenance a major layoff than to consider anything that would reduce the income of their longest-serving members. There may be some truth to that, but unions only represented about 12.5 per cent of the U.S. workforce as of 2005, and that number is falling. Clearly union resistance isn’t the key factor.

In fact, Bewley found that the strongest resistance came not from workers, but from the companies themselves, and the reasons are surprising. For one thing, he says, wage rollbacks are actually worse for worker morale than layoffs. When workers are fired, it generally sends a wave of discontent through the ranks. But then the affected employees are gone, and after a few weeks, things return more-or-less to normal. In contrast, when wages are cut, bad feelings linger in the office for months as employees grumble and debate whether they’ve been mistreated by management, and when they’ll get their “real” full paycheque back. Strange as it may seem, employers believe it’s actually less disruptive to simply fire people.

There are also reasons of efficiency and competitive advantage, Bewley says. Cutting wages across the board leaves a company vulnerable to having its best people recruited away by competitors. And while all HR people will tell you that a happy workplace is a successful workplace, a little bit of fear can have its advantages. Ruthless though it may be, studies indicate that staff work harder when they feel their jobs are at risk. Nothing focuses the mind quite like seeing the guy in the next cubicle get handed a severance cheque.

That’s why Sean McAlinden, an industry expert with the Center of Automotive Research, predicted last week that there would be massive layoffs in the auto industry in the coming months, but relatively modest contract concessions will leave pay scales basically intact. This will be done, he said, “with the collusion” of the UAW, as both management and union leadership agree that layoffs are more palatable than broad pay reductions.

Obama’s call for selflessness was inspiring. It even makes economic sense. But on this particular point, he is likely to be disappointed. Volunteer for a pay cut? Yes we can. But we probably won’t.


 
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