Wednesday, February 25, 2009

Pay cuts vs. layoffs

These days, there's a lot of talk about layoffs at big companies (and small companies), but there's a lot less talk about pay cuts, although notably, HP announced that regular employees will see a 5% cut in their income.  It might seem bad, but the effects are probably better than a 5% layoff, and here's why.

The labor market has been flooded for a while, now.  Even during the good times of the mid-2000s, it was an employer's market.  Qualified applicants had to apply for many positions, maybe got a few interviews, but just one job offer.  College students fought over internships to the point where industries took advantage of the scarcity of internships and made the positions unpaid, claiming the experience was pay enough.  When the economy declined, even more people entered the labor market due to layoffs, fewer openings for recent graduates, etc., but not only did the supply of labor go up, the demand went down.  Given typical supply and demand curves, the price of labor should fall, but it hasn't.

Part of this is due to government protection of workers through support of labor union monopolies and rights favoring workers.  During the Great Depression, a change in the Supreme Court, along with pro-labor policies and laws from congress, led to the rise of unions, in part because the plight of workers was more sympathetic than businesses.  The price floor the unions created limited the number of jobs available, despite a demand for labor the market would otherwise price cheaper.

Not only do liberal (as in free) labor policies lessen unemployment, they lessen recessions.  Given the threat of layoffs, people will prepare for the worst case, not the average case; think of it as employment terrorism.  Purchases of items are put off until they're either needed or the labor market is improving.  Pay cuts distribute the risk--a very socialist goal--through very free-market capitalist mechanisms, supply and demand.  Instead of an entire workforce preparing for the worst, a pay cut obligatorily prepares them for the expected, reducing a hoarding/layoff cascade through economy.

This doesn't work for every sector.  The velocity of money decreases in a recession, and any manufacturer needs to cut back to avoid a large, growing inventory.  Still, while more might not be a good option, better might be, and with cheap labor, a recession is a great time for a company with a solid balance sheet to develop next-generation products at a bargain basement price.

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