Pay cuts as a cure for recession

British Airways chair Willie Walsh has asked the company’s 40,000 employees to work unpaid for a month to save the company and their jobs.

The airline made a £401 million loss for the year ending in March. This seems to be due primarily to higher fuel prices, but partly to declining revenue. Total passengers seem to have fallen only slightly, but the number of business class and first class tickets fell by 13%, so it’s through the reduction in business trips that the global recession has stung.

According to a company spin doctor who spoke to the Guardian, some unspecified number of staff has taken the suggestion up. But it’s hard to imagine that a significant number of workers would do this off their own bat; if it happens at all, it will be through a collective agreement. Here the prospects don’t look good either: last week they asked ground crew to accept a pay cut or face voluntary redundancies, and the staff voted six to one against the deal.

Radio presenters yesterday were asking experts and callers for their opinions or interpretations, but it’s hard to provide either unless the question is clearly framed. There are a couple of quite distinct issues involved.

One question is whether it’s in the interest of the employees to accept a pay cut. Implicitly, the workers are being asked to donate to the firm on the promise of improved job security. But they must wonder why the firm’s long viability would be improved by a one-off payment (or a small wage cut, if you measure it as an annuity stream). If the business is viable under normal conditions, and is merely suffering a temporary revenue shortfall, then why don’t the owners bare the brunt, and why can’t they sell assets or borrow? If the company has no assets left to sell that it’s not using, and can’t get credit on reasonable terms from anywhere, then perhaps it’s reasonable to borrow from the workers as a last resort. But enlightenened governments should not allow matters to deteriorate to that point. Tax-payers will generally be willing to underwrite such a loan if convinced that the business in question is viable.

Alternatively, if, due to changing circumstances, international passenger air transport has been rendered permanently unprofitable at current wage rates, the market mechanism dictates some kind of rationalisation — which might involve contracting parts of the business and shedding workers. A temporary pay cut, even a large one, isn’t going to solve what is a permanent problem.

A third possibility is that the management has judged that, even though expected profits (in the statistical sense) looks good, it is now operating in an environment that’s fundamentally more uncertain than it used to be, and it wants the employees to share in the risk. This might be reasonable. But if British Airways wants to make its workers business partners, then the agreement should also involve bonuses in good times.

These are the issues that would need to be addressed if British Airways in isolation had suffered an unexpected, un-insured, one-off shock. But the global recession is a systemic problem, so the really important question is whether the problem of insufficient demand can be solved by the workers as a whole taking a pay cut, or transferring income back to the firm. In the current circumstances, the money wont be used to fund investment in plant and equipment that wouldnt otherwise have occurred. Most of it therefore will go to the firms shareholders creditors. Do they have a higher marginal propensity to consume than the workers who are losing the income; therefore a wholesale transfer of income is only going to reduce aggregate spending. Against this, it is likely that if British Airways can pay its debts this will prevent a few of its suppliers from going to the wall. But on balance, youd have to assume that, to the extent that the global recession is a result of slack demand, wage cuts will make it worse.

Now supposing for argument’s sake that it is definitely in the interest of workers in an individual firm to take a pay cut, then we have a clear-cut prisoners’ dilemma: the pay cut or transfer (however you want to look at it) is individually rational but collectively irrational. It parallels the situation of a bank in a recession — the individual bank has an interest in raising its rates and calling in its loans, but if every bank does that, it’s worse for everyone. Or, to use a classroom favourite, it’s like the dilemma you face when the cinema is on fire — do you rush to the exit, or follow directions in the interest of an orderly evacuation?

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14 years ago

Nice points James. Why, also, aren’t they tapping the owners of the business (the shareholders) for some money? Hell, why don’t they agree to issue shares to the employees in lieu of wages?

14 years ago

But enlightenened governments should not allow matters to deteriorate to that point. Tax-payers will generally be willing to underwrite such a loan if convinced that the business in question is viable.

wtf? I actually can’t get my head around this statement.

But I will go along if we actually ask taxpayers each time, via a referendum.

Joshua Gans
14 years ago

Patrick, I gather you’re not saying you don’t know what I mean. Nor are you simply disagreeing. So it’s something in between: you can’t comprehend why anyone would be so outrageous as to approve of governments’ bailing out firms from time to time. Is that right?

The plebiscite approach is a respectable one, but not widely supported by political scientists. How far would you personally take it? Should we have a referendum to increase nurses’ pay, or build a desalination plant??

14 years ago

It would be interesting to know what other industries have tried this one on. My feeling is that an airline, specifically it’s management, figure there is a certain esprit de corp it can ‘milk’ to get these things through, notwithstanding all the problems other posts have raised. You can imagine someone like Branson at Virgin putting the hard word on his staff by shear power of personality and, of course, a media event to demonstrate flag loyalty.

14 years ago

Pablo, some professional firms have instituted unpaid leave, and many manufacturers etc have reduced shifts which is the same.

James, I’m sorry, I should have tried to say something more reasonable and capable of response. Thanks for taking the effort in any case, I will try and re-formulate my reaction but really I think it is just an ideological gulf. I assume that your point is confined to exceptional circumstances of credit market failure, in which case it is a reasonable point even if I don’t really agree.

I think I was particularly ‘shocked’ by the conflation between government and taxpayers. Taxpayers are certainly not in favour of any such thing, imho. Whilst this is probably partly due to prejudices and ignorance, that doesn’t change it – I can’t imagine that ‘taxpayers’ as a whole would have voted for the bank bailouts overseas, for example. In practice in any case, it is governments who are the actors, not taxpayers, and to cite ‘taxpayers’ as approving of government action is often (imho) not very fair.

More generally I am just not conditioned to see government ‘picking winners’ like this.

Overall, I don’t see why this is the worst way to raise extra cash. The point I guess is that there is very little cash around. More borrowing would also mean more interest, thus negatively affecting cashflow, and asset sales at current prices would presumably also reduce cashflow even after paying down debt. But this way they get cash without doing anything ‘extra’ – almost free cash. I would hate to be working there, but seems reasonable enough.

All that said I would agitate if I were an employee for payment-in-lieu with shares. At current values it would seem rather attractive.

As for the plebiscite idea, well in practice I wouldn’t change very much about our Constitution at all. But if I was designing from scratch I might indeed have more plebiscites, notably I think I would have a plebiscite both to raise taxes and to incur a deficit.