Are Sticky Wages Stickier Than Sticky Buns?

Felix Salmon posts about the idea that employers don't like to reduce wages in a recession or economic downturn:

"David Leonhardt on deflation, Wednesday:

The drop in prices, which isn't over yet, will make life easier on millions of people. It's possible, in fact, that the current recession will do less harm to the typical family's income than it does to many other parts of the economy.
The reason is something called the sticky-wage theory. Economists have long been puzzled by the fact that most businesses simply will not cut their workers' pay, even in a downturn. Businesses routinely lay off 10 percent of their workers to cut costs. They almost never cut pay by 10 percent across the board.

Fedex press release, Thursday:

FedEx is now implementing a number of additional cost reduction initiatives to mitigate the effects of deteriorating business conditions, including:
Base salary decreases, effective January 1, 2009:
* 20% reduction for FedEx Corp. CEO Frederick W. Smith
* 7.5%-10.0% reduction for other senior FedEx executives
* 5.0% reduction for remaining U.S. salaried exempt personnel

Fedex is largely non-union, which means that most workers are taking a pay cut. I'm not sure this is necessarily a bad thing, if it avoids layoffs and reductions in service quality, instead spreading the pain around more thinly. But it does point to the possibility that this recession will indeed be different, and that it might mark the beginning of the end of sticky wages.( COULD BE. PROACTIVE FEAR OVERRIDING EVERYTHING ELSE )

There's been a huge shift in power in recent years from labor to capital: corporate profits have been rising much faster than wages for some time now ( DON'T TELL THAT TO PEOPLE WHO BELIEVE THAT ORGANIZED LABOR IS TOO POWERFUL ). It makes sense that capital would make use of its newfound power to reduce labor costs in a deflationary environment of rising unemployment. During the boom, companies laid off workers because those workers demanded, and cost, too much money. Now that workers have lost their negotiating leverage, we might start seeing more across-the-board pay cuts." ( COULD BE )

I would say that, in the case of FedEx, my understanding is that they are fighting for their life. In a possible bankruptcy situation, cutting wages is much easier. It might well be that in this current situation many businesses will end up near bankruptcy and that wage cuts could be higher than usual. It might also be that the fear and aversion to risk has effected workers to the point that lower wages in exchange for a job seems a good deal.

However, let me raise a few points:
1) Productivity is still rising
2) Worker's morale is not something you want to help depress in an already downbeat situation
3) As I pointed out in " I Don't Work In AIG Crap", workers who have made money for the company are not going to be happy taking a pay cut for other people's losses. It is possible that such treatment will lead them to look for another job, leading to the possible loss of the best employees of the business.

It might well turn out that wages aren't as sticky as they used to be, and it might also turn out to be a very bad thing for businesses and the economy, as well as the workers.

"the current recession will do less harm to the typical family’s income than it does to many other parts of the economy."

I've started calling these "Silver Lining Stories", but to me, again, there is a difference between falling prices and deflation. Yet, even in deflation, some people would turn out to be better off. Not everyone loses in deflation. This is not a new point. I've already posted about the possible benefits of falling commodities prices. From the NY Times, David Leonhardt:

"Very few Americans alive today can remember a time when prices across the economy were falling. But they’re falling now.

Multimedia

Graphic

Deflation Rears Its Head

"The cost of fruits, vegetables, clothing and vehicles are all dropping. Housing prices have been falling for more than two years, and a barrel of oil costs about $45, down from $145 in July.

The inflation report released by the government on Tuesday showed that the Consumer Price Index was 3 percent lower last month than it had been three months earlier. It was the steepest such drop since 1933.

These declines have raised fears of a deflationary spiral — fears that help explain the Federal Reserve’s surprisingly large interest rate reduction on Tuesday. And there is good reason to fear deflation. Once prices start to fall, many consumers may decide to reduce their spending even more than they already have. Why buy a minivan today, after all, if it’s going to be cheaper in a few months? Multiplied by millions, such decisions weaken the economy further, forcing companies to reduce prices even more. ( THAT'S THE WORRY )

But a truly destructive cycle of deflation is still not the most likely outcome. For one thing, the price of oil cannot fall by another $100 in the next few months. For another, the federal government will soon, finally, be fully engaged in trying to stimulate the economy.( TRUE )

In mechanical terms, the Fed’s rate cut is actually a decision to pump more money into the economy (which will cause short-term interest rates to fall) ( QUANTITATIVE EASING, PRINTING MONEY, DEBASING THE COINAGE ). Starting next year, the Obama administration is planning to spend hundreds of billions of dollars on public works and other programs. ( STIMULUS, KEYNESIAN )

All else being equal, more money sloshing around an economy causes prices to rise. In this case, it will probably keep them from falling as much as they otherwise would have. ( TRUE. GRANT BELIEVES THAT THEY SHOULD BE ALLOWED TO FALL )

So amid all the legitimate worries about deflation, it’s worth considering what may be the one silver lining in the incredibly bad run of recent economic news: The cost of living is falling. ( TRUE )

Jobs are disappearing, bonuses are shrinking and raises will be hard to come by. But the drop in prices, which isn’t over yet, will make life easier on millions of people. It’s possible, in fact, that the current recession will do less harm to the typical family’s income than it does to many other parts of the economy. ( TRUE )

The reason is something called the sticky-wage theory. Economists have long been puzzled by the fact that most businesses simply will not cut their workers’ pay, even in a downturn. Businesses routinely lay off 10 percent of their workers to cut costs. They almost never cut pay by 10 percent across the board.

Traditional economic theory doesn’t do a good job of explaining this. During a recession, the price of hamburgers, shirts, cars and airline tickets falls. But the price of labor does not. It’s sticky.

In the 1990s, a Yale economist named Truman Bewley set out to solve this riddle by interviewing hundreds of executives, union officials and consultants. He emerged believing there was only one good explanation.

“Reducing the pay of existing employees was nearly unthinkable because of the impact of worker attitudes,” he wrote in his book “Why Wages Don’t Fall During a Recession,” summarizing the view of a typical executive he interviewed. “The advantage of layoffs over pay reduction was that they ‘get the misery out the door.’ ” ( I AGREE WITH ATTITUDES BEING THE CAUSE )

Companies resort to cutting jobs and giving only meager pay increases, increases that are even smaller than the low rate of inflation that’s typical during a recession. This recession may well be the worst in a generation — but thanks to the stickiness of wages, the pay drop for most families may not be much worse than that of a typical recession.( TRUE )

The forecasting firm IHS Global Insight predicts that prices will fall by an additional 1 percent in 2009. That would bring the total drop, from the summer of 2008 to the end of 2009, to roughly 4 percent. But you can be sure that most executives will not force their workers to take a 4 percent cut in their paychecks. The fears about morale will be too great.( TRUE. MORALE IS IMPORTANT )

Strange as it sounds, the drop in prices will keep real incomes — inflation-adjusted incomes — from dropping too much. ( TRUE )

I don’t mean to make things sound better than they are. The economy is bad and getting worse. A deflationary spiral remains a real threat, even if it’s not the most likely result. No matter what, unemployment is headed much higher.

People who keep their jobs, meanwhile, will suffer through some stealth pay cuts — higher health insurance premiums, for instance. Raises will also remain meager in 2010, even if prices start rising again. Like every other recent recession, this one will force families to take an effective pay cut, and a significant one.

But the drop in prices will still soften the blow. And at this point, American families can use any bit of economic help that they can get."

It's all true, but, remember, we don't know exactly what Deflation would actually lead to. It might well change the terms on which a lot of these silver lining stories are based upon.