The Danger of Wage Cuts

The Washington Post perfectly fails to summarize the problem in its headline, "Wage Growth Is Eroding As Firms Rush To Slim Down". Um, actually, most of the examples in the piece show extreme wage cuts, not an erosion of growth. As Hilzoy notes, the bottom 90% of wage earners saw their wages "grow" a mere 10% over the past 30 years, while those in the top 10% grew 232%. Wages are falling now for that same group of workers not at the very top, because the threat of job loss forces them to accept cuts. And the result for the broader economy is tragic.

Suppose that workers at the XYZ Corporation accept a pay cut. That lets XYZ management cut prices, making its products more competitive. Sales rise, and more workers can keep their jobs. So you might think that wage cuts raise employment — which they do at the level of the individual employer.

But if everyone takes a pay cut, nobody gains a competitive advantage. So there’s no benefit to the economy from lower wages. Meanwhile, the fall in wages can worsen the economy’s problems on other fronts.

In particular, falling wages, and hence falling incomes, worsen the problem of excessive debt: your monthly mortgage payments don’t go down with your paycheck. America came into this crisis with household debt as a percentage of income at its highest level since the 1930s. Families are trying to work that debt down by saving more than they have in a decade — but as wages fall, they’re chasing a moving target. And the rising burden of debt will put downward pressure on consumer spending, keeping the economy depressed.

Constant wage deflation led to economic stagnation in Japan in the 1990s. That's what it looks like we're saddled with. There's a difference between saving the economy and leading to a real recovery. Wage cuts lead to the former but not the latter.