Pay cuts in a recession

Pay cuts and pay freezes are being flagged up as an increasingly common option by businesses struggling to survive in the early stages of the recession. Formula 1 drivers are being asked to consider cuts in their earnings as teams look to control costs ahead of the 2009 season; staff working for the publisher Penguin who earn over £30,000 have had their salaries frozen. Premier Rugby in Britain will agree, next month, on a reduction in the salary cap from £4m to £3.5m. And a new survey from the British Chambers of Commerce covering 300 member firms has found that 43% plan to freeze wages and salaries in the coming year. Nearly one business in ten will go a step further and attempt to cut basic pay and salaries – a measure described in this article from the Sunday Times as “almost unprecedented in the experience of today’s workers.”

Implications of pay cuts

There are many broader economic effects of a situation in which wage packets and salaries are either held constant or cut. Here are some of the possible questions and implications that come to mind.

Pension incomes:
Effects on the pensions of people who are on final salary schemes - pay cuts over the next couple of wage bargaining cycles could have a damaging effect on their pension incomes over the longer term. This will be fiercely resisted by trade unions - especially those representing workers in the state sector

Productivity and efficiency:
Will reductions in pay lead to lower productivity? Pay cuts of 10 per cent or a freeze on wages (which amounts to a cut in real pay) could have a negative effect on worker morale.

Equity
Will pay cuts be across the board from executive level through to shop-floor workers?

Impact on consumer demand:
Will a squeeze on real take-home incomes lead to an even deeper cut in consumer spending - aggravating the extent of the recession in the domestic economy? Many businesses will be using a mixture of layoffs, reduced hours, less overtime and wage freezes - all of which have a negative effect on average earnings.

Public and private sector divides:
Will the government attempt to introduce pay freezes for public sector workers? During the long boom, many thousands of state-employees lost out in relative terms as pay and earnings in the private sector of the economy surged ahead.

A freeze for the minimum wage?
What will happen to the value of the National Minimum Wage which at present stands at £5.73 an hour for workers aged over 22 but is set to rise in October 2008?

Wages and monetary policy decisions
How might a deceleration in the rate of growth of wages affect the interest rate decisions by the Bank of England? In the past they have been watching for signs of a rise in wage inflation as a possible cause of cost push inflation. If wage increases drop sharply, the risks of cost and price deflation are accentuated but there may be little that they can do with interest rates to respond.

Strong A2 students understand the inter-relationships between the wider economy and the labour market - pay and wage bargaining is a crucial part of this and affects concepts such as the NAIRU and the Phillips Curve relationships.