Wage Cuts, Once Unthinkable, May Become a Common Cost-Cutting Tool

Three weeks after the Oct. 29, 1929, stock market crash, Henry Ford emerged from a meeting with President Hoover and made a startling announcement to the press in Washington. He would raise wages at his plants to help his workers get through the current economic “dislocation.” In early December, he made good on his promise, and minimum daily wage rates rose from $6 to $7.

Ford’s action was innovative and completely contrary to traditional business practice. In the pre-Depression era, maintaining wage rates--let alone raising them--in an economic downturn was unheard of.

Up until the 1930s, employers had always reacted to periodic “panics” and periods of deflation by slicing wages. The six-year downturn that followed the Panic of 1873 saw wage cuts by the railroads, then the nation’s largest employer, coal mines, shoe makers, cigar makers and the textile industry, to name a few. But interestingly, these wage cuts did not match the magnitude of the era’s deflation, and real, or inflation-adjusted, wages held steady.

A similar circumstance occurred in the sharp depression of 1921-22. Once again, employers were quick to push wages down in the face of falling prices and profits--but prices were falling so quickly that real wages actually rose.

President Hoover, however, had observed the 1921 depression from the vantage point of Commerce secretary, and he believed that these wage cuts had increased the severity of past depressions. Determined not to repeat that error, he called business and labor leaders to Washington immediately after the Crash and forged a tacit “wage truce”: Unions would not press for wage increases in return for business holding wages steady--hence Henry Ford’s announcement.

But the wage truce proved only temporary. The relentless pressure on businesses to reduce costs was overwhelming, and eventually, wages had to give way: pay cuts began in earnest in late 1930 and 1931.

Then, of course, Roosevelt and his New Deal entered the scene. Spurred by a sense of duty toward the distressed, and not by any Keynesian notion of the value of counter-cyclical expenditures by the federal government, Roosevelt signed into law the Social Security Act in 1935, which provided benefits for the poor, elderly, disabled and blind, and set up unemployment insurance. That was followed in 1938 by the Fair Labor Standards Act, which created minimum wage and maximum-hour laws.

With this sweeping legislation, Roosevelt created both a microeconomic floor under wages and, even more important, the macroeconomic “automatic stabilizers”--expenditures that rise in bad times and fall in good--which have helped reduce the depth and duration of postwar recessions, thus removing much of the classic downward pressure on wages.

However, the automatic stabilizers are far from the only force that has interrupted the long history of wage reductions in tough times. U.S. industry reigned supreme after World War II--no foreign competitors were left standing; U.S. consumers had plenty of savings and pent-up demand from both the war and the Depression. Wages rose steadily in the absence of any pressure to the contrary.

But this happy time came to a fairly abrupt end in the 1970s when the United States, had become a high-cost producer, .and businesses pushed wages ever higher to keep abreast of the era’s rampant inflation.

By the 1980s, the upward pressure on wages was losing some of its force. U.S. manufacturing responded to the growth of foreign competition with major productivity improvements--and looked eagerly for ways to cut costs.

The social pressure against wage cuts is enormous, making this cost-cutting tactic just about unusable. So inventive employers have turned to means other than explicit wage cuts to carve away at their wage bills: layoffs, closing facilities and moving jobs overseas.

Businesses also have held down their wage bills by keeping wage gains below inflation’s rise. As a result, although few explicit wage reductions have been made, certainly real wages have been feeling the crunch.

And the pressure on business to be more competitive is going to continue. Services are only now feeling the heat of competition, as we have discussed many times, and there is plenty of fat to cut. Furthermore, my forecast of low inflation in the United States also means that businesses will not be able to control their wage bills by holding pay increases below inflation.

Wage cuts were once an ordinary occurrence, part of almost every employee’s expectations, but have become unthinkable since the Depression. Some industries, such as airlines, have had to resort to actual wage cuts in order to survive. Perhaps others may begin to explore wage reductions as a way to cut costs.

In the meantime, as the stop-go United States economy of the 1990s continues, implicit wage reductions--perhaps, in time, even more explicit wage cuts--will continue.