Sticky Wages, Sticky Expectations: The Case for Accepting a Smaller Salary

Unemployment Report by Mike Licht, NotionsCapital.com, on Flickr

In times of recession, we are often plagued by what economists call "sticky wages": when demand falls, wages don't.  The result is falling output and rising unemployment.    You can argue that we'd all be better off if everyone took a 10% pay cut, rather than most people keeping their salaries, while a minority gets a 100% pay cut. (More later on why this is a complicated question).    But such an argument is rather academic, since this is not what happens.

It's easy enough to understand why it doesn't, within existing firms: workers are not going to react well to an announcement that everyone's taking a pay cut. (Witness the Verizon workers out on a bitter strike over higher contributions to their health insurance.)  But it's more of a puzzle for the unemployed.  Surely, something is better than nothing, and we shouldn't have to worry about loss aversion, since you've already lost your job.

Tyler Cowen has been blogging this question, with interesting response from Scott Sumner and others. This morning he posts a reader comment, which suggests an intuitively plausible solution to this puzzle: it's the employer, not the workers, who drive wage stickiness for the unemployed.  Willingness to accept lower wages grows rapidly as the term of unemployment stretches out.  But willingness to offer lower wages may not.

This makes a lot of sense.  You can tell a story where people are just stupid and stubborn, but it's not really a very plausible story--eventually, those people have to eat.  But for employers, it's different.  There are usually other workers applying for any given job.  Hiring someone who has previously made more is risky: they may be malcontent.  Or they may leave you as soon as they see a better opportunity.

This also might help explain why it took World War II to end the unemployment of the 1930s. There weren't other workers who were available, so employers overcame reservations about things like wage stickiness and long-term unemployment.

Of course, we're not going to have World War II again, so what can an individual do?

Come up with a good story about why you're willing to accept lower wages.  When I was interviewing for my first job at The Economist, they asked me flat out why an MBA would be willing to take a job that paid $40,000.  Part of the answer was, of course, that I needed a job.  But that's not what I said.  What I said was also true: "I'm only going to be on the planet for a few short years.  I want to do something that's a lot more important to me than making money."

I got the job.  It now occurs to me that I might not, if my answer had sounded anything like "I need a job."