Why employers facing a recession will eliminate jobs and slash benefits before they cut wages
The parallels between the current economic downturn and the Great Depression are often scary. This is the first time since the 1930s that the U.S. has experienced big, extended declines in house prices. And as in the Depression, the financial system is under extreme stress.
But there is one important way in which history is not repeating itself. Average annual earnings of workers fell for several years in the 1930s but have not fallen since. And it looks like they won't fall in 2009, either. Businesses are reporting that they plan to increase pay by roughly 3.5% in 2009 for U.S. workers, according to recent surveys by compensation consultants Mercer, Watson Wyatt Worldwide (WW), and Hewitt Associates (HEW). Salary increases are crucial because rising wages make it easier for some families to pay their debts.
By penciling in pay hikes, employers are signaling that they don't believe that the U.S. government will flub policy so badly that the country succumbs to another depression. Their plan to raise pay is good for the economy: Lenders will be more likely to make loans if they think families will have the income to pay them back. Households will be less afraid to shop. "Confidence is crucial to limiting the negative effect of the current financial crisis," says International Monetary Fund economist Luca Antonio Ricci.
The news isn't all good. Pay hikes may fall below current expectations, and while employers are planning to raise pay, they are simultaneously cutting jobs. The jobless rate hit 6.5% in October, and many economists think it could reach 8% by late 2009. Employers are also looking for less conspicuous ways to save on benefits, such as reducing 401(k) matches or increasing deductibles and co-payments in health plans. A Watson Wyatt Worldwide survey in mid-October showed that 26% of employers were planning layoffs or other reductions in force in the coming 12 months, while 25% planned to raise employee contributions for health care. In contrast, only 4% were planning to cut salaries. "Firms are cutting workers instead of wages," says Ethan S. Harris, co-head of U.S. economics at Barclays Capital in New York.
By raising pay while cutting jobs, companies can "thin the herd" while giving remaining workers "the big corporate hug they need," says William C. Yoh, CEO and president of Yoh, a unit of Day & Zimmerman Group that supplies high-tech temps. Starbucks (SBUX) recently announced it was cutting jobs but isn't cutting pay or benefits. "We have to take care of our partners [i.e., employees] and keep them engaged," says spokeswoman Tara Darrow.
Companies are cutting bonuses, which have accounted for a growing share of compensation for many workers. But at some companies, bonuses are so important that reducing them can be as traumatic as slashing base pay. That's one reason Wall Street resists calls from Washington to eliminate or sharply restrict their bonuses. Law firms have even less to gain from trimming bonuses because they account for only a small portion of associates' pay. "Firms are kind of locked into laying off or not laying off," says Dan DiPietro, head of a Citigroup (C) unit that lends to law firms.
That leaves benefit cuts, which are more likely than pay cuts to escape employees' notice. Edward Kaplan, national health practice leader for Segal Co., an employee benefits consulting firm in New York, says one employer he deals with has excluded coverage for Nexium and Prevacid, the much-prescribed heartburn medicines, saying there are plenty of generic substitutes available. Those medicines account for 7% of the employer's drug costs.
Of course, some hard-pressed companies are cutting or freezing pay. Nortel Networks (NT) and American Express (AXP) both announced salary freezes for many employees. The mayor of Columbus, Ohio, is freezing 2009 pay for himself and 400 other employees. And in Los Angeles, restaurant operator Grill Concepts (GRIL) is slicing top executives' pay 10% in an effort to avoid job cuts. Says Grill Concepts Chief Executive Officer Philip Gay: "It doesn't make you feel good when you go home at night if you've let people go."
But those are the exceptions. There's a good chance that if you keep your job in 2009, you'll get a raise. What's more impressive is that the raise is likely to be greater than the rate of inflation. That's because inflation is plummeting. The median estimate of economists for 2009 inflation is just 1.5%, according to a Bloomberg survey released Nov. 12.
Why raise inflation-adjusted pay in the teeth of a severe recession? After all, theory says that the price of labor should adjust to the demand for it. Theory also says that workers and employers alike should care only about pay adjusted for inflation. In reality, though, both groups tend to get anchored to certain pay hike numbers (4% is a favorite) regardless of changes in the rate of inflation.
That may be one reason employers haven't shaved much off their 2009 pay-hike forecasts. Amazingly, Mercer found that 2009 salary-increase budget projections for 190 U.S. companies barely declined from April to October (from 3.7% to 3.6%) despite a steep decline in projected inflation. "I wouldn't say inflation rates plus or minus are causative" in setting pay, says Laura Sejen, Watson Wyatt's practice director for strategic rewards.
Americans have a lot to worry about in 2009. But for now, pay cuts are not at the top of the list.