Job Cut vs. Pay cut: The Prudent Choice

Job Cut vs. Pay Cut: The Prudent Choice[1]
: D. C. Pathak[2]

The world is facing a grave financial crisis these days. Varied responses/opinions have come to deal with this crisis; from extensive bailout plans to job cuts and pay cuts. As this crisis has put a question on the credibility of all economic thinking[i], debate is on over its various implications and the future course of action. Like other countries, India is not immune to this crisis. A decision to cut jobs by the Jet Airways due to the present financial crisis fueled a debate. Though the decision has been reversed, the debate is yet to settle. An issue has come up with Jet’s employees accepting a pay cut in lieu of job cut about the reparability of the two. An article at the website ‘Knowledge@Wharton’ presents varied view on the issue of job cut vs. pay cut in details. The article mainly contemplates the issue from HR point of view. The present article has tried to deal with the economic aspect of the issue.

Before proceeding on to make arguments, it would be better to discuss the assumptions behind the arguments.
Workers from one sector/industry can’t be employed in some other sector/industry due to specialized skills needed. It means, inter-sector/industry mobility of labour is zero.
Job cut implies a zero income, i.e., .
Pay cut implies that the new income stream would be less than the original income stream but would be significantly greater than the . It implies that
4. All workers have some accumulated savings.
5. Savings are a function of income , i.e.,
6. All savings are invested.

Suppose a firm was paying its employees Rs. 100/month. Now it wants to downsize by Rs. 1000. It has two choices: either it go for a job cut of 10 employees or it can go far a pay cut of say, 100 employees, cutting Rs. 10 from each employee’s salary. Other firms in the industry would face the similar choice. Though both options look alike but they affect the employee and the economy differently. In the first case of job cut, the income streams accruing to employees would become zero. So, now they will have recourse to only there accumulated savings. Though number wise the job cut would seem insignificant, but when one considers the hefty pay packets these employees get, it would be quite significant financially. Being a rational consumer, the out-of-job employees would cut his expenditures drastically as he would not want to finish up his all savings. Cut in expenditures would lead to fall in demand. Since the supply would take some time to fall, the result would be a general oversupply of goods leading to a price fall. Falling prices would create a panic among the producers and they would reduce their inventories and may also resort to job cuts if they feel the low demand condition to continue. This situation if left to feed on itself unchecked, would lead to depression in the economy. Also the out-of-job people would not make any saving so that part of money supply would reduce which depend on savings by these people. A fall is money supply means a high rate of interest. A high rate of interest would lead to a fall in investment decision. This chain of events would again lead to depression in the economy.
One can safely assume that the people with pay cut would expect even the worst and therefore wouldn’t draw heavily on their accumulated savings. They will, instead, go far a reduction in consumption expenditure. Even this reduction should be less than that for the out-of-job people. The people with pay cuts would also reduce or in some extreme cases stop making new savings. This would reduce the money supply but by much less extent than for the case of out-of-job people. A comparatively less reduction in money supply implies that the increase in the rate of interest would be comparatively less in case of pay cut. Thus, if all the firms in the economy opt for a general pay cut rather than a general job cut, the chances of the economy falling in grip of depression would reduce. As the employees can’t move across industries owing to specialized skills requirements, a general job cut would create an unused skill-pool. A drawback of specialization is that one loses touch with other common tasks which fall outside the gambit of this sector/industry. Such employees feel the punch the hardest as they found it very hard to get and do well in some other sector/industry. Though they're good at what they know, they're worthless in such a situation, a kind of paradox. Thus, from an economic point of view, a general pay cut is preferable to a general job cut. An across the board pay cut would even motivate the employees by instilling a feeling of oneness and kinship in the firm. This may work miracles as the collective will can attain anything.
Apart from above economic arguments, there are also some other arguments[ii] against job cut. To list a few,
1. As rightly pointed out by an article in Knowledge at Wharton by title 'Job Cut vs. Pay Cut: In a Slowing Economy, What is Better for India?'[iii], losing a job creates an image of incompetence in the mind of family and friends. Even more dangerous is that it would lower the self-esteem of an individual and that can lead to further decline/irreparable damage to his/her self-image and efficiency.
Losing a lucrative job would plunge the person in a quagmire of depression, affecting the mental health of the person and his family/friends.
As an extreme step, the employee may commit suicide also. News about suicide by people due to loss in the stock-market has come recently.




[1] The motivation for this write up came from Roberta Shell’s article in ‘Knowledge@Wharton’.
[2] The author is a Senior Research Fellow at the OKD Institute of Social Change and Development, Guwahati (India).
[i] See “Economics needs a scientific revolution”, an essay by Jean-Philippe Bouchaud in NATURE, Vol 455, 30 October 2008. Also see the blog posting: http://misplacedemphasis.blogspot.com/2008/11/economics-needs-scientific-revolution.html

[ii] Can be assessed at http://durgeshonomics.blogspot.com/2008/11/should-we-cut-jobs-or-downsize-pay.html
[iii] This article can assessed at http://knowledge.wharton.upenn.edu/article.cfm?articleid=4333 and presents varied opinions by several persons.