Layoffs or Pay Cuts: Which is best? : Planet Money Companies hammered by the economic collapse due to the coronavirus pandemic are being forced to make a hard choice: lay staff off or cut their pay.
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Pay Cuts Vs. Layoffs

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Pay Cuts Vs. Layoffs

Pay Cuts Vs. Layoffs

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UNIDENTIFIED PERSON, BYLINE: NPR.

(SOUNDBITE OF DROP ELECTRIC SONG, "WAKING UP TO THE FIRE")

CARDIFF GARCIA, HOST:

Hey, everyone. Stacey and Cardiff here. This is THE INDICATOR FROM PLANET MONEY. In past recessions, before the one we're in now, whenever companies needed to cut costs, cut their labor costs especially, they generally resorted to layoffs. And so some portion of the workforce would end up losing their jobs.

STACEY VANEK SMITH, HOST:

And, of course, there's already been a staggering number of layoffs in this recession, especially by companies that have been forced to shut down because of coronavirus. But there are also a lot of companies that have opted for something else. They've chosen to cut workers pay instead of laying them off.

GARCIA: Yeah. These are companies like General Motors, Ford, Sotheby's, Occidental Petroleum, Steelcase, Boston Scientific and so many more - companies that in the past might have resorted to layoffs first. And also, by the way, one of the companies doing pay cuts is NPR.

VANEK SMITH: Yes. We got word of this last week. But this raises a question - why haven't companies done more of this in the past? Why have they preferred layoffs in past recessions. And also, why are a lot of companies suddenly trying to pay cuts in this recession? Karl Smith is an economist. And he's the vice president for federal tax and economic policy at the Tax Foundation, a think tank. And he has been looking into this question of layoffs versus pay cuts.

GARCIA: Yeah. Karl says that historically, companies have preferred layoffs because cutting the pay of their workers would violate an implicit contract between the company and those workers - that if these workers come in and do their jobs, they'll get paid the salary that was agreed upon.

KARL SMITH: And companies are afraid that if they violate that contract, that's going to hurt morale among people. People - you know, they're going to - suddenly, the employees they have are going to have problems paying their bills, you know, maybe meeting their mortgage. And in particular, what's going to happen is the sort of productivity and morale of the employees who are still there is going to go down.

GARCIA: Psychologically, there is something kind of strange about having your pay cut. When a company first agrees to pay your salary, it is implicitly telling you that that's how much it values your work. And so when you get a pay cut, it can feel like the company is suddenly telling you - literally from one week to the next - that your work is worth a bit less, even though you're the same person doing the same exact work.

VANEK SMITH: Yeah. And if you think about the other side of that, if a worker violated their side of the contract and, like, didn't show up five days a week or something, there would be very real consequences.

SMITH: So there are those sort of psychological issues where people attached a value to their day, to their work, to their experience, to everything they bring to the company. And if you're giving them less than that, again, that's a psychological hit. That's a morale hit. Am I not worth as much anymore? - all those kinds of issues the employee is dealing with.

VANEK SMITH: And, you know, in the thick of a recession, even if workers are upset about a pay cut, they're probably not going to leave because there are not many options for places to go work during a recession. But once there is an option of leaving, once the economy maybe starts to look a little better again, there is research showing that it's the company's best workers who are the first ones to leave if a company has cut their pay. And that makes the company overall less productive going forward.

GARCIA: And, of course, from the standpoint of any single individual worker, a pay cut is obviously much better than losing your job, when all of your pay is suddenly gone. But historically, that's not really a decisive factor for companies deciding what to do, Karl says. It can sound harsh, but the people who've been laid off are just kind of on their own from the standpoint of the company.

SMITH: And so they're not contributing to this sort of decline in productivity and, potentially, morale. In fact, in some cases, the employees who were saved feel lucky to have a job rather than to be - have been laid off. So instead of an entire floor full of people who are grumpy and dealing with bill problems, you get rid of some people, place the burden on them and then protect the ones that you have left. That's the basic reasoning that we think is there.

VANEK SMITH: That is why the traditional approach of companies has been layoffs instead of pay cuts. So why is it that all of these companies are now experimenting with pay cuts in this recession? The answer after a quick break.

(SOUNDBITE OF DROP ELECTRIC SONG, "WAKING UP TO THE FIRE")

GARCIA: According to economist Karl Smith, when it comes to the tradeoffs that a company has to make between layoffs and pay cuts, this recession is different.

SMITH: Number is that because of the pandemic, there is a sense of sort of shared sacrifice, that this is happening to everyone. Everybody is suffering. And if we're asking you to suffer that's not so much, you know, a greedy corporate action as it is our collective response.

VANEK SMITH: Basically, that old implicit contract, which is that your company will keep paying you whatever salary you decided on when you started, has been replaced by a new contract. And the new contract says, hey, our struggles are not the result of bad management or better competition or even a housing crisis. Our struggles are the result of this massive external shock, this virus that's causing damage to the whole world. So when a company asks you to take a pay cut, it doesn't necessarily feel like it's devaluing your work because this economic pain, this pandemic - it's everywhere.

GARCIA: And also, Karl adds, in this recession, there is still some hope that the economy has been deliberately shut down only for a while but that, eventually, as the economy comes back, companies will go back to paying workers what they were making before the pandemic. That may not prove true. But at least for now, it makes pay cuts an easier sell for companies to make to their workers.

VANEK SMITH: Plus, if the economy does start to recover soon, then pay cuts might end up having been a better business strategy for companies than layoffs because by avoiding layoffs now, companies won't have to go out and hire back their old workers when they want them back, Karl says.

SMITH: Another part that I think is, you know, increasingly appreciated by economists is that it just takes a long time to, like, repair and rebuild relationships.

GARCIA: So keeping the workers on staff can be good for the overall economy, too, Karl says, because those workers are probably a pretty good match for the job they're already in. They have the training to do that job. And, obviously, they have the experience. So when the economy does start to bounce back, companies won't need to take time finding and training new workers to do the jobs that they need done.

SMITH: And so to the extent that we can avoid breaking any employer-employee relationship, that's going to make recovery a lot faster than it otherwise would be.

VANEK SMITH: In fact, keeping those relationships in place has been one of the goals of the government's response to the downturn. In the stimulus bill that was passed in March, small businesses can get grants from the government if they keep their employees on their payrolls. And they can still qualify for those grants if they cut their workers pay by up to 25 percent.

GARCIA: Still, even if pay cuts are better than layoffs, the workers who get those pay cuts are still going to have a tougher time paying some of their bills, especially those big bills that are fixed that can't be changed, like a mortgage payment if you're a homeowner or the monthly rent if you're a renter. Karl says the government should consider doing still more to help out these workers.

SMITH: One of the things that you can do - and we see this, you know, in some other countries. And, in fact, the administration is talking about doing now - is the government could sort of subsidize, you know, some of employers' pay. And so that would allow the employer to pay a little bit less if the government says, well, we're going to cover sort of 20% of employment cost. But the United States so far hasn't been as aggressive in doing that as some other countries. So to the extent that you wanted to maintain those relationships, that would be a good way to go.

GARCIA: And at least in our case here at NPR, we got the news that NPR was going to be cutting our pay. Well, obviously, that's not great. But, Stacey, you and I talked about it when it happened. And I remember the overwhelming feeling was actually one of gratitude and maybe relief that there wouldn't be layoffs, that we wouldn't lose our jobs but also that our colleagues would not lose theirs.

VANEK SMITH: Yeah, exactly. I mean, there's not just a relationship between workers and the company. There's the relationship between workers themselves. So there's this idea that, like, we can all take a pay cut and help our colleagues and ourselves keep our jobs. Like, that's sort of a nice feeling of solidarity in a way, even though, of course, nobody wants to get paid less.

GARCIA: This episode of THE INDICATOR was produced by Darius Rafieyan. It was fact-checked by Brittany Cronin. THE INDICATOR's editor is Paddy Hirsch. And THE INDICATOR is a production of NPR.

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