Wednesday, September 16, 2009

Recessions and sticky wages

David Leonhardt points to one of the more remarkable aspects of the current recession - the lack of decline in wages and even small increase in wages. Businesses appear to have responded to the downturn by virtually freezing new hires. However, unlike previous recessions, there was no sharp increase in lay-offs and discharges nor widespread wage cuts. This trend is a testament to the increasing premium commanded by skilled work forces in the modern economy.



In other words, all the opportunities for new workers were virtually blacked out. And even for those laid off, finding newer jobs became a huge challenge, taking those out of work for more than six months to its highest ever share. Leonhardt describes this trend of some firing and virtually no hiring as "concentration of pain".

As economies become more skill-driven and globally integrated, businesses will increasingly lose the flexibility to lower wages in response to slowdowns. Wage cuts would have the effect of de-motivating the remaining workforce and/or drive them elsewhere across the world. In the circumstances, wages will become even more sticky downwards.

In the absence of freedom to lower wages, businesses will resort to firing their most dispensable category of workers. An indicator of this trend is the steep jump in unemployment rates from 6.7% in 2007 to 15.5% in May 2009. Though detailed category-wise lay-off figures are not available, I am inclined to believe that those lower down the knowledge chain bore the brunt of the firings during the Great Recession and will continue to do so in the future. In fact, the BLS figures for lay-offs and separations show the largest increases in retial trade, hospitality and construction industries. This would ironically mean that those least responsible for economic downturns will be the worst affected during bad times. The poorest are the worst affected by recessions (US poverty rate rose from 12.5% to 13.2% from 2007 to 2008). Heads you win, tails I lose!

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