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How Many Layoffs Could Be Avoided by Pay Cuts?

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Amid a backdrop of low inflation and a tight labor market, a survey of unemployment insurance (UI) recipients in Illinois during 2018-19 yields new insights about wage inflexibility, even when layoffs loom.

More than half of the UI recipients said they would accept wage cuts of 5-10% to hold onto their job for at least another year. Remarkably, nearly a third stated they would accept a 25% pay cut to save their lost job. Those with high wages (compared to observationally similar workers) were much more willing to accept pay cuts to save those jobs.

Yet hardly any of these workers had discussions with their employers about possible cuts in pay, benefits, or working hours as an alternative to layoffs. In fact, a mere 3% recalled such conversations, and hardly any had experienced a wage cut in the year leading to their layoffs. Our survey is the first to document this striking disjunction between worker-side openness to wage cuts and a widespread unwillingness of employers to even broach the subject.

When we ask UI recipients why discussions about job-saving pay cuts don’t happen, nearly 40% don’t know. A similar share thinks pay cuts would not save their jobs, and 16 percent say pay cuts would undermine morale or lead the best workers to quit. For those who lost union jobs, 45 percent say contractual restrictions prevent wage cuts. 

We also use our survey data to look for job-saving pay cuts small enough to be acceptable to the job loser and large enough (in the worker’s estimation) to save the lost job. An estimated one-quarter of the layoffs in our sample meet both conditions. This result is noteworthy for two reasons. First, it suggests that many layoffs are avoidable by pay cuts of the right size. Second, it contradicts many prevailing theories of layoffs and unemployment, implying that a deeper, more intricate understanding is needed to fully grasp why and when layoffs happen.

In future work, we plan to implement a two-prong survey design that asks job losers and their former employers about the same layoff and wage-reduction events. We seek new insights into how managerial practices, third-party mediation efforts, and sound policies can foster better communications between managers and workers and greater contractual flexibility. Ultimately, the goal is to reduce layoffs and the fiscal strains on the unemployment insurance system. 

© Pawel M. Krolikowski and Steven J. Davis

Pawel M. Krolikowski is Senior Research Economist at the Federal Reserve Bank of Cleveland

Steven J. Davis is Professor of International Business and Economics at The University of Chicago Booth School of Business and IZA Research Fellow

Please note:
We recognize that IZA World of Labor articles may prompt discussion and possibly controversy. Opinion pieces, such as the one above, capture ideas and debates concisely, and anchor them with real-world examples. Opinions stated here do not necessarily reflect those of the IZA.

Related IZA World of Labor content:

Efficiency wages: Variants and implications by Ekkehart Schlicht

Alternative dispute resolution by David L. Dickinson

Foto by Ryoji Iwata on Unsplash