Sticky Wages

Imagine you’re an employer during a recession, and you desperately need to cut labor costs to keep your firm afloat. Are you more likely to cut wages across the board for all employees, or institute layoffs for only some?

While it may seem that wage cuts are the “better” choice, they aren’t as common as you might think. Why is that?

To answer that question, this video explores a phenomenon known as “sticky wages.”

In other words, wages have a tendency to get “stuck” and not adjust downwards. This occurs even during a recession, when falling wages would help end the recession more quickly.

However, that’s not to say that wages cannot adjust downward for an individual during a recession. This can happen, but likely only after an employee has been fired from their initial job, and eventually rehired by a different firm at a lower wage rate.

Back to our original question -- why are employers unlikely to cut wages? A big reason has to do with the effect on morale. Employees may become disgruntled and angry when they experience a nominal wage cut, and become less productive.

An important note here -- notice that we said nominal wage cut, meaning, not adjusted for inflation. If an employee receives a 3% raise in nominal wages, they may remain happy in their current position. But what if inflation is 5%? What does this mean for their real wage? (Hint: For an in depth answer to this question check out our earlier Macroeconomics video on “money illusion.”)

Next week we’ll return to our discussion on the AD/AS model for a look at how factors such as “sticky wages” affect the economy in the short run.

[PseudoJuju]

I wonder if sticky wages apply also to CEOs and executives. Are they so keen to cut their own wages in order to adjust for a recession or depression?

[TheDominock]

Amazing explanation. Thank you, well done.

[Atheist-Libertarian]

I am not even a economics student, but don't know why I am continuously watching videos after videos from this channel.

[msdm]

It's a lot to do with contacts and replaceability. Employees are slow to accept a wage cut, while an inflation real cut they can't do anything about. Employees can often be difficult to replace and mess up the supply chain, especially if many go at the same time, so those Employees have a better negotiation positions.

[salomelapiashvili]

The fact that Mr. Tyler EXPOSED HIS BROTHER LIKE THAT.... damn...

[ThePeterDislikeShow]

How about during the better times instead of giving raises give bonuses so that it's not expected, and then not giving the bonus or giving a smaller bonus during the recession, so it doesn't look like a cut? Can that work?

[MrRichman]

Thanks for the awesome videos! I'm about to kick my Macro Final's butt thanks to you guys. Keep up the awesome work

[kameshthukkaram]

Thanks for your excellent explanation and practice questions. Hats off!

[byrdiethemighty]

Productivity has only gone up since the 70s and yet wages have not kept up, the minimum wage should, at minimum, be $25 to keep up with the standards prior to the Reagan administration. These workers have only increase productivity since then due to technological advances. The employers need workers more than visa versa. They just own a factory full of capital and tools and no product, collecting dust. All wage labor cannot match the productivity of the worker so all wages can increase at the expense of profit. It's that simple. They would pay you less if they could but Just like the government has the right to demand safe working conditions, the government has the right to enforce minimum wage, or demand overtime pay to workers, or child labor laws. The government fundamentally has the right to ensure workers are compensated and able to participate in the economy they helped create. That is the contract between the business and government. In order for the business to have access to resources like land and the roads that and workers, they have to follow safety and environmental standards and pay their workers at least federal minimum wage. Paying a livable wage would even see business becoming winners as their workforce now may eat, which would lead to an even higher productivity. Just ask yourself; how would you design a society if you didn't know your role in it?

[gaylethomas]

Management learns from experience that when wages are lowered and morale slips, the most productive and most easily employed workers find better-paying jobs elsewhere. On the other hand, when management lays off a percentage of workers, they select the least productive workers to lay off.

There is also an effective wage cut when workers maintain the same wages but take on the work load of the laid-off workers. Workers don't seem to mind that as much, either.

[dailtonluizmagnagojunior]

Amazing expanation... simple and clear!

[chqnnel]

This man is a money wizard. I swear I’m drinking his tea

[linzartz]

Can you share a video on New Keynesian macroeconomics?

[Xamarin]

I think that the stickiness of wages should be dependant on how big the wage is.

At minimum wage (for that which is required to maintain, perhaps, at least a lower-middle-class standard of living), I think the wages should absolutely be sticky because any further decreases to minimum wage-workers' pay might sink their lives into (further) poverty.

At wages far above the minimum wage for a decent standard of living (e.g, the wages of big company CEOs, billionaires, other rich people, etc), I think that wages should not be sticky at all and that if anything, the wages of the wealthiest should be first considered for being cut, since they have plenty. It is unfortunate that those with the least are typically first prioritized for getting fired or wage cuts than those with the most.

[kevinxu]

Question. What about instead of cutting wages, employers cut the hours of the employees and keep the same hourly rate?

[bigcat]

Here's a question, why hasn't the market adapted to this fact? Why aren't (some) companies keeping money on the side to use to buy up newly available talented workers during these recessions?

[adrianomattia]

will you publish a video about the short-run aggregate supply?
good video by the way

[anggaraadhari]

it's blow my mind about employee morale

[quangnghialam]

Could you please add English sub below? My English listening skill is not so good. If EngSub is available, it will be easy for me to understand. Thank you!

[adamnash]

Money illusion... Wait why would employees wages get cut with zero inflation going on? You can't give a example and change the control variable(inflation rate) and give a result you're bias towards, it's not a fair comparison.