Bryan Caplan  

The Tears of Termination

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Costco vs. Wal-Mart... Farewell to a great historian...
Earlier this year, I argued that Casey Mulligan's theory of labor market contradicts introspection:
Ask yourself:

When someone gets laid-off, what is his main emotional reaction likely to be? 

Sorrow.

When someone gets a nominal wage cut, what is his main emotional reaction likely to be? 

Anger.
I was amused, then, to discover that the Handbook of Employee Termination has a whole section on "Dealing with Six Types of Emotional Reactions" to dismissal.  "Crying" is #1.  The whole list:

1. Crying.
2. Shouting and Cursing.
3. Withdrawal.
4. Flight or Fight.
5. Offender. [When the employee is being summarily discharged for a criminal offense].
6. Defender. [When the employee is being discharged for insubordination.]

The "Crying" paragraph is worth quoting in its entirety:
Do not try to make the terminated employee stop crying; weeping can be therapeutic.  Give him or her time to recover.  Maintain your composure while you are waiting.  Do not apologize to the individual, but show your concern.  Offer a tissue or a glass of water.  This will buy time and allow the individual to regain self-control.  Keep your goal of efficiently conducting the interview in mind, and use this time to plan the next step.
Yes, unemployment really is a grave evil.  Fortunately, this evil is avoidable.  We just need to make wages far more flexible.  The first step is radical labor market deregulation.  The second step is a massive cultural shift: We have to know in our heads and feel in ours hearts that wage cuts are the potent, humane medicine that prevents and cures the plague of unemployment.



COMMENTS (18 to date)
Jim Rose writes:

allan manning argues the same

That important frictions exist in the labor market seems undeniable: people go to the pub to celebrate when they get a job rather than greeting the news with the shrug of the shoulders that we might expect if labor markets were frictionless.

And people go to the pub to drown their sorrows when they lose their job rather than picking up another one straight away.

The importance of frictions has been recognized since at least the work of Stigler (1961, 1962).

Thomas DeMeo writes:

I understand your argument, but you have never extended it to explore its effect on employers. This is a massive shift in risk from employer to employee. Employers would be far more likely to take chances than they are today. Would it make for a better, more stable economy? I'm not so sure.

Barry Soetoro writes:

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Yancey Ward writes:

Thomas,

What do you mean when you write "stability"?

RohanV writes:

If a company cuts wages, won't its best workers jump ship to a competitor? After all, their skill is above average so they will be able to find a job or command a higher wage more easily.

Like if your university cut salaries, sure, the bulk of the professors would grin and bear it. But your superstars would leave.

With wage cuts I think you'd be left with a cheaper, but less qualified workforce. If you fire people, you have fewer employees, but you retain the more qualified ones.

Thomas DeMeo writes:

Yancey Ward - What do you mean when you write "stability"?

Now when times are tough, wages don't go down, but an extra 5% or so of the work force is unemployed. Flexible wages will work if everyone keeps their jobs, and the wages fluctuate by roughly the same 5%.

However, employers may start to change their behavior as a result. If wages start to have larger and larger fluctuations over successive business cycles, that would be the type of instability I'd be worried about.

Thomas DeMeo writes:

Yancey Ward - What do you mean when you write "stability"?

Now when times are tough, wages don't go down, but an extra 5% or so of the work force is unemployed. Flexible wages will work if everyone keeps their jobs, and the wages fluctuate by roughly the same 5%.

However, employers may start to change their behavior as a result. If wages start to have larger and larger fluctuations over successive business cycles, that would be the type of instability I'd be worried about.

Nathan Smith writes:

Consider the following explanation of why workers resist wage cuts.

When a worker accepts a job, he and his employer probably had a lot of other options. He's just been job hunting, and he likely had several leads. He is temporarily quite savvy about the job market. The opportunity cost of taking this job, and not another, is relatively high.

Once he settles in, he stops reading the classified ads. He loses touch with recommenders and head hunters etc. He unsubscribes from job websites. He neglects to update his resume. His opportunity cost of staying at the job falls.

So if his employer offers $70K, then cuts his wage to $50K two months into the job, it might be in his interest to stay. In the short run, at least.

Of course, his employer might not want to do that, because the worker's productivity is probably rising with his duration of employment. On his first day, the new employee is probably a drag on productivity. Three months in, maybe he's actually getting useful. For some jobs, it may be years before his learning curve starts to level out.

And so a hard-bargaining employee might be able to demand a big raise after the first year, and it might be worth the employer's while to give it. In the short run, at least.

Employers and employees adapt to each other. That makes them a lot less replaceable. It opens the door to opportunism. And wage stickiness is the solution to that. You're not afraid to let your employer train you in a highly company-specific skill, because you expect him to keep paying you the same wage.

I suspect that the cultural shift Bryan advocates would be undesirable. If it were more acceptable to jerk people's wages up and down, it would be harder for organizations to eliminate internal game-playing and foster productive teamwork.

Steve Z writes:

RohanV:

Are you assuming that companies would slash wages the same for every employee, regardless of ability? Why?

ThomasH writes:

"this evil [unemployment] is avoidable. We just need to make wages far more flexible." Or maintain NGDP growth through better monetary policy and, if that fails or is not undertaken, and real interest rates fall and resources become unemployed, for governments to engage in activities that they normally do not because the do not have positive net present values when evaluated at the scarcity values that fully employed resources have.
And flexible wages are nice, too.

ThomasH writes:

The idea that the large increase in unemployment of factory buildings, rental apartments, machines, etc. was due to an outbreak of wage inflexibility is pretty absurd.

RohanV writes:

SteveZ:

You get the same essentially the same problem with any subset of workers. Of the set of workers who have their wages cut, the best of them will try and leave. Now maybe you can rig it so that you only cut wages from workers who are of low enough quality such that they won't be able to find another job easily. But I think that will be hard.

As well, since you are cutting wages of a smaller number of people who don't earn as much, you have to cut more per person. That in turn makes it even more likely that you will lose those people. So you might as well fire them.

Here's an example with three workers:

Anna - Skill A - $100K
Betty - Skill B - $60K
Charity - Skill C - $40K

You want to cut 20% (40K) of your payroll.

Scenario 1:

You cut everyone's wage by 20%. Anna leaves you for Google.

So now you have Betty at $48k and Charity at $32K. You do have $80k to hire someone else, but that's not enough to hire a Class A person, so you might have to get another Class B person.

Result = 2B + C

Scenario 2:

You cut Betty and Charity's wage by 40%. Anna ($100k) and Charity ($24k) stay, but Betty ($36k) leaves. You now have $36k free and can hire another Class C person.

Result = A + 2C

Scenario 3:

You fire Charity. Anna and Betty stay.

Result = A + B

You have less people, but the ones you have are higher quality. You are probably not able to do as much as you did before, but you are more likely to succeed at the things you do attempt.

Brian writes:

RohanV has it exactly right. It's the same thing I commented in Bryan's later post, but with more detail than I provided.

There's also another reason why cutting wages by ability doesn't work. Differences in wage cuts are perceived as being unfair. It's a great way to destroy company morale. On top of that, those who don't have their salaries cut still see the cuts that others receive and figure they'll be next. They start looking for a new job to stave off the inevitable, and likely end up leaving.

There are so many reasons why Bryan's complaint about layoffs and sticky wages is misguided. But ultimately the problem is that wage cuts attempt to keep people employed with lower productivity, and this is not in anyone's interest.

Jim Rose writes:

how is losing a job any different from any other capital loss? people are upset whe the share market crashes and when their car breaks down.

Steve Z writes:

RohanV:

Thank you for the detailed explanation. But what is to prevent the Class-A person from getting a job offer at higher salary, and then using it to negotiate a higher wage? In my experience, that's what top-notch employees do. Also, even if the company you are focusing on loses out, the companies that receive the Class A/B defectors win out, so maybe it's a KH improvement.

However, I am predisposed to think that both you and Brian must be right: it's a hard pill to swallow that employers are systemically irrational.

RohanV writes:

Steve Z:

Well, in my example, let's just say that Google is willing to pay the Class A person $100k. So before the wage cut it's not worth leaving or negotiating, but after the wage cut it is.

As for the KH improvement overall, maybe that's true. But the person making the wage cut or firing decision belongs to the losing company. She's going to make the decision that hurts her company the least, not the one which improves her competitors.

RohanV writes:

Steve Z:

Well, in my example, let's just say that Google is willing to pay the Class A person $100k. So before the wage cut it's not worth leaving or negotiating, but after the wage cut it is.

As for the KH improvement overall, maybe that's true. But the person making the wage cut or firing decision belongs to the losing company. She's going to make the decision that hurts her company the least, not the one which improves her competitors.

Steve Z writes:

But the wage-reducing company doesn't know that Google is willing to pay $100k before they lowered worker A's wage. So they've gained valuable information. And if Google isn't willing to offer $100k, then they've gained valuable information and also reduced the amount they are paying out.

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