Federal Reserve Bank of Cleveland: 'Sticky Wages on the Layoff Margin'

CLEVELAND, Ohio, July 3 (TNSrep) -- The Federal Reserve Bank of Cleveland issued the following working paper (No. 23-12) on May 15, 2023, entitled "Sticky Wages on the Layoff Margin."

The working paper was written by Steven J. Davis and senior research economist Pawel M. Krolikowski.

Here are excerpts:

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Abstract

We design and field an innovative survey of unemployment insurance (UI) recipients that yields new insights about wage stickiness on the layoff margin. Most UI recipients express a willingness to accept wage cuts of 5-10 percent to save their jobs, and one-third would accept a 25 percent cut. Yet worker-employer discussions about cuts in pay, benefits, or hours in lieu of layoffs are exceedingly rare. When asked why employers don't raise the possibility of job-preserving pay cuts, four-in-ten UI recipients don't know. Sixteen percent say cuts would undermine morale or lead the best workers to quit, and 39 percent don't think wage cuts would save their jobs. For those who lost union jobs, 45 percent say contractual restrictions prevent wage cuts. Among those on permanent layoff who reject our hypothetical pay cuts, half say they have better outside options, and 38 percent regard the proposed pay cut as insulting. Our results suggest that wage cuts acceptable to both worker and employer could potentially prevent a quarter of the layoffs in our sample. We draw on our findings and other evidence to assess theories of wage stickiness and its role in layoffs.

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1 Introduction

We design and field an innovative survey of unemployment insurance (UI) recipients that yields new insights about wage rigidity on the layoff margin. Specifically, we ask new UI recipients about their willingness to accept wage cuts to save their lost jobs, whether they had discussions with their former employers about compensation cuts in lieu of job loss, and, if not, why not. Our survey went to field in the state of Illinois from September 2018 to July 2019, a period characterized by unusually low inflation and tight labor markets.

Most UI recipients in our sample express a willingness to accept wage cuts of 5-10 percent to save their lost jobs, and one-third are willing to take a 25 percent cut. Yet worker-employer discussions about cuts in pay, benefits, or hours to prevent layoffs almost never happen.

When asked why, nearly four-in-ten UI recipients do not know. Thirty-nine percent think wage cuts would not save their jobs, and 16 percent say pay cuts would undermine morale or lead the best workers to quit. For those who lost union jobs, 45 percent say contractual restrictions prevent wage cuts. Our results suggest that wage cuts acceptable to both the job loser and the former employer could potentially prevent about a quarter of the layoffs.

When UI recipients refuse our proposed wage cuts to save their jobs, we ask why. Among those who experienced permanent layoffs (four-fifths of our sample), half point to better outside options, 38 percent regard the proposed pay cut as insulting, and one-fifth prefer unemployment to working at the lower wage. Among those on temporary layoff, the most common reason for refusing a hypothetical wage cut is fear it might become permanent.

Our finding that employers do not offer pay cuts in lieu of layoffs is broadly consistent with evidence from employer surveys.1 While we draw inspiration from these studies, our worker-side survey offers distinct insights and advantages. First, it reveals that most new UI recipients would accept wage cuts in lieu of layoffs, and many are open to large wage cuts.

Employers' reluctance to offer wage cuts becomes more puzzling in the face of widespread workers' willingness to accept them. Second, our survey approach lets us explore workers' perceptions about why employers do not offer pay cuts to save jobs. Many simply do not know. Third, employer-side surveys of wage-setting behavior typically involve small samples compiled by cold calling firms and snowball sampling. (Bertheau et al., 2022, is a notable exception.) In contrast, our sample frame is precisely defined, and our sample design lends itself to a systematic, institutionalized approach with ongoing surveys.

To our knowledge, we are the first to document the disjunction between worker-side openness to wage cuts and a pervasive unwillingness of employers to even broach the subject.

We can discard a few possible explanations for this disjunction. First, less than 3 percent...

1 See, for example, Kaufman (1984), Blinder and Choi (1990), Agell and Lundborg (1995), Campbell and Kamlani (1997), Bewley (1999), and Babeck'y et al. (2010).

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...of respondents point to minimum wage and benefit laws to explain why discussions about compensation cuts don't happen. Moreover, only 4 percent report an hourly pay rate on their lost job less than 1.05 times the legal minimum. Second, we ask specifically about lower pay for 12 months to save the lost job. Thus, worker-side openness to wage cuts does not reflect an intention to seek and quickly take a better-paying job. Third, job losers in our sample seldom experience pay cuts in the months leading up to layoffs. That is, we see almost no indication that employers try job-saving wage cuts before resorting to layoffs.

By targeting UI recipients, our sample frame and survey data let us develop new insights about sticky wages on the layoff margin. If sticky wages cause some workers to lose jobs and obtain UI benefits, our frame captures them. On the flip side, our frame selects against employment relationships that survive negative shocks by virtue of downward wage adjustments. Thus, we cannot use our sample to quantify the incidence of job-preserving downward wage adjustments. That said, very few job losers report discussions about compensation cuts to prevent layoffs--irrespective of industry, union status, tenure on the lost job, firm size, and other observables. If employer-worker discussions about wage cuts to save jobs were common, we would expect those discussions to succeed in some instances and fail in others. The failures would show up in our sample. That so few do indicates that discussions about job-preserving wage cuts rarely happen.

The rarity of employer-worker discussions about pay cuts in lieu of layoffs sits uneasily with theories that stress private information about outside options as a source of wage stickiness and privately inefficient layoffs. These theories lead us to anticipate efforts to overcome informational impediments to the preservation of valuable matches. That we see so few instances of such efforts raises a challenge for these theories, which we put in the form of a question: If private information leads to the dissolution of valuable matches, why don't employers (and workers) make greater efforts to overcome informational asymmetries?

To our knowledge, theoretical work has not addressed this challenge. Nor are we aware of empirical research on the issue.

The next section expands on the motivation for our study. Section 3 describes our survey, reports summary statistics, and offers evidence on the quality of the survey data. Section 4 documents the willingness of UI recipients to accept job-preserving wage cuts and the dearth of discussions about pay cuts to save jobs. Section 5 explores workers' perceptions about the reasons for sticky wages on the layoff margin and why many job losers refuse wage cuts.

Section 5 also quantifies the share of layoffs that could be avoided by wage cuts that are acceptable to the job loser and his or her former employer. Section 6 discusses our findings in relationship to the literature and draws some additional lessons from case studies. Section 7 offers concluding remarks.

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Citation: Davis, Steven J. and Pawel M. Krolikowski. 2023. "Sticky Wages on the Layoff Margin." Working Paper No. 23-12. Federal Reserve Bank of Cleveland. https://doi.org/10.26509/frbc-wp-202312.

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The white paper is posted at: https://www.clevelandfed.org/-/media/project/clevelandfedtenant/clevelandfedsite/publications/working-papers/2023/wp2312.pdf