Pay Cuts in Salaries and Wages

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Being anxious to be called Scrooge and worse, and not having enough e-mails that criticize me in every which way, I bring you a page or two of, I hope, truthful observations on a verboten subject: pay cuts.

If pay cuts sound too cruel, let us call them pay reductions.

I no longer work for a living. I was a salaried employee at a public university or two. I have not been a wage-earner. I have never experienced wage reductions. I am not living hand-to-mouth or in poverty. Readers who demand certain solidarity qualifications from me may stop reading at this point.

For approximately 18 years of my adult life, my income was very small. Budgeting and economizing were habitual and pervasive. This extended, among other things, to eating liver rather than steak, walking instead of driving, and having roommates. After getting a decent paying job, I experienced significant wealth losses, tantamount to pay cuts, due to unanticipated inflation, taxation, and tax increases. I exacerbated this by being silly enough to save. I also failed to take on debt that was tax-deductible and that I could have paid off with cheaper dollars. None of this qualifies me either to speak on the politically incorrect subject of wage cuts.

Salary and wage cuts are a politically incorrect subject in America because they are inconsistent with the reigning orthodoxy of Keynesianism and worship of government solutions.

In a world with downward flexible wages and salaries, the unemployment that occurs in a depression is brought to an end more quickly. It is when wages and salary reductions become off-limits and are kept high that the unemployment is prolonged. The anti-pay cut attitude is intentional among statist economists. It opens the door to the Keynesian "solution" of inflation and government spending, which is what they support.

In a depression, prices of goods decline. They cannot be produced profitably unless costs also decline, and labor costs are the largest part of costs of many goods. Asking too high a price for one’s labor puts one out of work. After a while, the unemployed accept lower pay anyway in order to get work. Many unemployed end up finding new and different jobs at lower pay. If they had stayed at their old jobs for which they were trained and in which they had skills, and accepted lower pay, they often would have been better off.

Pay cuts are not a norm in our society. They are frowned on. Executives are reluctant to institute them. Those who are paid for their labor resist them mightily. The public is taught to resist pay cuts and support those who resist them. We should change these attitudes. We are hurting ourselves. These ideas play into the hands of big government. The government becomes bigger and more intrusive by discouraging wage cuts, supporting labor in its resistance to wage cuts, and promising an inflationary remedy to unemployment. It gets to spend what are now trillions. This "remedy" worsens the economy. If it works at all, it works very badly. Economist W. H. Hutt explains this in great detail in The Keynesian Episode.

A week or two ago, a bullish development occurred. It went little-noticed or remarked. It was that Korea was embarking on pay cuts of about 20 percent. This, it seemed to me, was very good news. This will speed the end to the depression in Korea. Somewhere in the world there was some enlightenment.

When people keep working, even at a reduced pay, they produce product in demand. The worth of this product, which is shared by the factors of production that include labor and capital, provides the wherewithal to buy the production of others. The true and sustainable and non-inflationary source of demand for the goods of others is one’s own production. And since there is a multitude of goods in any economy whose prices are in constant adjustment to one another, these kinds of demands are in tune with consumer wants. They involve a minimum of waste and a maximum of satisfaction of wants.

By contrast, the Keynesian answer, which is a government attempt to stimulate the economy, to the extent that it works at all, is unsustainable, inflationary, wasteful, and not focused on consumer wants. Throwing money at public projects does not resolve the specific dis-coordination and specific mal-investments of the prior boom. It results in some people making more money who service these projects, while many others end up employed at lower-paying jobs. It ends up with a larger and less efficient government sector with taxes permanently higher. The Keynesian answer, which is general inflation, supports unions, especially those with cost-of-living protection. It helps public sector unions that deal with cronies in government. It hurts non-union labor. It hurts the general public. It hurts the economy as a whole. And it produces all the many pernicious effects of inflation.

The price system in free markets works for the general betterment. The price system works even better and even faster if pay falls when the situation calls for lower pay. In that case, the economy will come out of the depression faster. This means that real incomes can increase at a faster pace. The U.S. economy could get past the slow and anemic recoveries that it has been experiencing in which unemployment and under-employment drag on for years on end.

If the federal and state governments really wanted to spur the economy, they could hold out for salary and wage cuts of their employees along with concomitant tax rebates. There is no doubt that governments should be cutting their costs too. When government employees, who are already overpaid, keep getting the same pay, it means that taxes remain as high as ever. The tax burden goes up relative to private income. Those taxes increase the discouragement of work and effort in the private economy. They raise unemployment.

We are seeing salary and wage cuts in the U.S. and this is a good thing. They will speed the end of the depression. There is news of reductions in the states of Michigan and New York. There is news at a number of specific companies and other organizations such as hospitals and symphonies. There are pay cuts occurring in Estonia. The cuts are 10 to 20 percent. I am certain that a complete search will turn up many more cases. In the article on Estonia, one executive says the following:

"At times I don’t understand what’s the fuss around the salary cuts. It’s normal that salaries rise when the economy is doing well. It’s normal that currently, when the economy is doing bad, salaries fall. I think that those companies, which do so, want to be effective."

This is a down-to-earth and sensible way of looking at it. In bad times when prices fall, the price of labor has to fall too, or else the unemployment will go on and on.

If pay reductions in these times are a good idea, as they are, then resistance to them is a bad idea. Beware rationalizations of holding pay where it is and fighting pay cuts. That is counterproductive. A prime example is before Congress today. The Senate is voting on an amendment proposed by Senator Vitter

"…that would require members to vote publicly on their annual pay increases instead of the current system that lets it kick in automatically. While it may seem like a political no-brainer, if the amendment passes and changes the underlying bill, Democratic leaders have suggested they’d pull the bill from the floor. u2018This system of automatic, auto-pilot pay raise really is offensive to the American people,’ Vitter said in a speech on the Senate floor. u2018There never has to be any inconvenient debate, any inconvenient votes whatsoever. They just happen automatically, no votes.’"

Government, which should serve people, instead rules people and serves the interest of the rulers. In this time of economic distress, the Senate should be leading the way by cutting its own pay. If by maintaining their high pay and pensions, we, their supposed employers, saw fit to lay them off permanently, that would be even better. However, we have yet to gain control over them or our government.

Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York.

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