During the recent downturn, as with every recession that preceded it, companies have responded to declining demand mostly by laying off workers while leaving the salaries of remaining employees largely untouched. This peculiar habit of firing workers rather than cutting wages poses a bit of a challenge to standard economic theory. Workers receive valuable on-the-job training that disappears with layoffs; new hires will need to be trained from scratch when the economy rebounds. Unemployment can be devastating for workers and their familiesâ€”most would prefer a 10 percent wage cut over a 10 percent chance of getting fired. Consequently, almost any model of rational behavior would have employers and employees renegotiating labor contracts during tight times to push down wages in order to keep more workers employed.
A series of studies in the burgeoning field of behavioral economics provide some insight into why managers seem to prefer handing out pink slips rather than lowering salaries. In experiments where workers were randomly assigned to receive wage cuts, they retaliated by slacking off. If you know that anger and resentment accompany pay cuts, it's easier to understand the response of management during recessions.