Why Pay Cuts Are Welcome

Last Updated Apr 29, 2009 5:37 AM EDT

When is a pay cut a pay rise? When the economy is in deflation. If prices are falling, then the same amount of money buys more goods so a wage freeze is a real increase. Employees may start to find that forfeiting a pay rise may be better than forgoing their pay entirely.

Just as a 10 per cent pay rise when prices were soaring by 20 per cent was a real fall in income, a small pay cut now could secure jobs while maintaining spending power.

Given that most business has taken pay rises off the agenda, according to a survey by the British Chambers of Commerce, it is something employees need to consider. Some 58 per cent of firms claim they will freeze pay this year and another 12 per cent will cut pay.

High inflation is an opportunity for business to rebalance labour costs -- it allows for uneven rises in pay. But negative inflation is an opportunity, too -- if some salaries rise while others fall, differentials can be widened or narrowed to suit changed circumstances. It gives management the flexibility to manage.

But make no mistake -- pay cuts apply to management as much as entry level jobs. Cutting employment costs can keep a sinking business afloat, providing the cashflow to cut debt or even the capital to expand.

In a market economy, pay should reflect supply and demand. Just as wages rise when there is a shortage of workers, they should fall when there is a surplus.

The self-employed and those relying on commission have seen their pay fall as prices and sales volumes tumble.

New managers can be recruited at rates below their predecessors', but in practical terms, most employee pay can be cut only by reducing hours and overtime, or in real terms by failing to match inflation.

Freezing wages when inflation is negative is an increase in real pay but it is a useful reminder why annual wage increases should not be automatic.

The Post Office faces a fight with its unions to implement a proposed pay freeze, but the Chambers survey suggests it will have many allies in the private sector.

A bold government would now see that the easiest start to its planned cuts in public spending would be to deny increases to all public-sector workers -- at all levels.

Most employees recognise, too, that a job without a pay rise is better than no job at all -- better we all take a one per cent cut in income than we add one per cent to unemployment and then tax the well-paid majority to finance the additional jobless.

If unions want an issue to fight, then trading pay cuts against job guarantees is a good start. Deflation will provide the pay rises.