Posted by: Dirk | December 4, 2007

Why wages don’t fall during a recession

The book by Bewley (1999) with the above title is described by the publisher’s website:

He found that the executives were averse to cutting wages of either current employees or new hires, even during the economic downturn when demand for their products fell sharply. They believed that cutting wages would hurt morale, which they felt was critical in gaining the cooperation of their employees and in convincing them to internalize the managers’ objectives for the company. Bewley’s findings contradict most theories of wage rigidity and provide fascinating insights into the problems businesses face that prevent labor markets from clearing.

The research was conducted by interviews during a recession, and basically confirmed what Keynes said in his Genereal Theory:

Except in a socialised community where wage-policy is settled by decree, there is no means of securing uniform wage reductions for every class of labour. The result can only be brought about by a series of gradual, irregular changes, justifiable on no criterion of social justice or economic expediency, and probably completed only after wasteful and disastrous struggles, where those in the weakest bargaining position will suffer relatively to the rest.

This is quite interesting with respect to the current situation of the Eurozone. A lot of countries used to devaluate when the economy was not running well. Now they have to face an appreciating euro, and with inflation around 3 per cent interest rates will probably stay high for a little longer. With the ECB unwilling to intervene, pressure might arise for a political solution.

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