As I noted recently, the U was considering some salary cuts for next fiscal year. (It's now looking like salary cuts might not happen next year, because the legislature is going to use some federal stimulus dollars to support higher ed.) Utah State already cut everyone's pay by 2% for this year.
In other news, IBM announced higher profits, and shortly thereafter, a round of layoffs.
Both IBM and Utah State are trying to reduce labor costs. Why is one doing it through layoffs and one through salary cuts?
This is actually one of the big questions in economics. Wages, it turns out, tend to be sticky in the downward direction. And this is weird.
In a normal market, prices fall when demand goes down. Think about what's happened with oil recently. Demand has fallen, and so has the price. The price falls so that quantity demanded and quantity supplied are the same --- the market is in equilibrium.
IBM's demand for labor has fallen. Are they cutting wages? No --- IBM is keeping wages the same for the workers who keep their jobs. The fact that wages stay the same means that the quantity of labor demanded and the quantity of labor supplied are not the same. We've got an excess supply of labor. We call this "unemployment".
In some sense, it would be better if firms cut wages rather than cutting people. Why? Let's apply some marginal analysis to the question of how many workers a firm should employ. A firm should keep hiring until the worker's marginal revenue product --- that is, the extra revenue the firm makes as a result of hiring the next worker --- is no longer larger than the wage.
So let's suppose times are "good", and my marginal revenue product at my employer is $105. If my wage is $100, then the firm is happy to employ me, because it earns $5 in profit. If times turn "bad", my marginal revenue product might fall (due to decreased demand for my employer's products) to $95. If I'm bringing in $95 to the firm but costing the firm $100, then I'm a prime target for a layoff.
But what if I'd rather work for $90 than be unemployed? Then the firm and I can both be made better off if I stay employed but take a wage cut. If the firm lays me off, then it earns $0 and I am unemployed. If the firm keeps me around but cuts my pay to $90, then the firm earns $5 and I stay out of the unemployment line.
In that sense, salary cuts make both parties better off.
But in the real world, things are more complex. And this is due in large part to asymmetric information problems.
In real recessions, employees don't really know their marginal revenue products. And as a result, employees might worry that firms are using the recession as a pretext for cutting pay. An employee might wonder "Are times really so bad? Or is my employer simply using the recession as an excuse to cut pay so it can make more profits?"
This is the sort of thing that could make employees mad. And employees can do a lot of subtle things to retaliate against an employer who they think has treated them badly.
As a result, a firm might be better off cutting employees rather than cutting salaries. The employees who are let go will be unhappy, but they won't be around to cause trouble.
The argument I'm sketching here is laid out in a book by Yale economist Truman Bewley. This is truly one of the most unusual books in economics: Bewley is quite famous as a serious math-econ theorist, but in this book he eschews math entirely and simply goes out to interview managers and ask them why they do what they do.
It seems to me that this recession is seeing more across-the-board salary cuts than we've seen in the past. A former student sends in this article about Microsoft. I have not seen any data on this point, but I'm sure some enterprising labor economist will be exploring this question soon.
One reason might be scale of this downturn. Because everyone knows that this recession is pretty bad, employees might not be as prone to think that employers are simply using the recession as an excuse to cut pay. But at least some MSFT employees seem pretty grumpy about the whole deal.
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2 comments:
Hi Scott,
Glad to see you are blogging. I really enjoyed your class!
I would say your hypothesis is correct.
New York is borrowing $20 million a day to pay unemployment claims. Ohio borrowed $500 million to get through March. Kentucky borrowed $280 million to get to June. In summary there were 14 states at the end of January that were borrowing to cover current unemployment claims.
California is completely insolvent and I don't expect them to survive beyond the next six months. Mexico is on the verge of civil war and depending on the timing of that....will effect all the border states. Texas is the most prepared and their National Guard is currently on high alert.
I think the current economic landscape is just beginning the downward spiral. As a people we are insolvent. No way out of this mess and nothing but pain ahead.
Not trying to be a downer but at the end of the day, that's the reality check!
Scott,
Excellent points - I am trying to get my arms around this issue of employee morale, wage cuts, layoffs, and company performance. Feels like there are great opportunities for forge strong corporate cultures by being "humane" in an economic crisis such as this, but at the same time the cash pressures are severe. With both my company and those of my clients, there is a constant balance on this issue that is the heart of managing in a uniquely challenging environment like this.
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