Cutting Wages is Bad for Unemployment

Joe Weinlick
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Unemployment is a tough pill for anyone to swallow. Professionals are constantly looking for work in an environment plagued by sticky wages and decreased demand in labor. Though the unemployment rate has dropped considerably since the beginning of the recession, jobs are still in short supply. Those currently working, however, can rest assured that most companies won’t be cutting wages any time soon — but how does this affect the unemployed?

Cutting wages is one of the most common answers proposed to a struggling company. Money that is currently spent on payroll can thus be used elsewhere — so why aren't companies doing more wage cutting?

Sticky wages play an important role in this proposed solution. The Sticky Wage theory is a hypothesis developed by economists that suggests wages respond far more slowly to the company’s — or the nation’s — economic performance. For example, a struggling company is far less likely to give wage cuts because most believe that cutting wages will lead to a lot of internal stress and upset. No one likes seeing the numbers go down from pay check to pay check. So, rather than pull money from pay checks, companies are more likely to enact rounds of layoffs instead, which leads to wage stickiness.But how do sticky wages make unemployment even worse?

By forcing companies to make rounds of layoffs rather than cutting wages, workers are keeping companies in a position that makes it difficult to recover; the chances of a company hiring while simultaneously laying people off is extremely low. Plus, layoffs are far more accepted by the media and business world than wage cuts. Thus, sticky wages create a cycle that is difficult for companies to break.

If a company can’t reallocate funds by cutting wages into critical business expenses, they don’t immediately turn around and fire enough employees to break even. Instead, it’s suggested that wage stickiness forces companies into keeping high prices, which decreases the demand for goods and services — which, when enough companies are in this situation, creates more layoffs and perpetuates the recession. Companies that can’t afford to keep on their employees will certainly not show any interest in hiring new ones.

Unemployment is a difficult situation for any professional, but it becomes even more difficult when companies begin cutting wages or enacting layoffs. Sticky wages play a big role in how the business world deals and recovers from recession and economic stress. Companies that don’t cut wages are laying off employees or struggling from inflated prices while demand decreases.

By cutting wages, companies create a sense of low morale that reduces quality, and often quantity, of production. However, layoffs are just as hurtful to the economy and employment as cutting wages in that they create even more unemployment.

 

Image courtesy of jypsygen on Flickr.com


 

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