The humane alternative to job cuts

In a recession, many firms see revenue decreases and this means they have less money for labor. They are then inclined to cut jobs. Of course, in the long run this can't be good, for the unemployed workers will cut down on their spending, hurting the revenues of other businesses who then lay off their workers.

This is not to say that all lay-offs are always bad. But the best time for a company to streamline is in a relatively slow but steady season in a strong economy, where managers could let go unproductive and redundant workers. At least the workers have a better chance of landing on their feet elsewhere.

The more humane thing to do in a recession is pay cuts. Instead of laying off 10% of the workforce, cut everyone's wages by 10%. But that's impossible, because a substantial amount of the worker's payment is in health care costs, the employer's share of FICA taxes, and other employer contributions to benefits packages.

And this reveals an underlying flaw in our economy. Instead of employees paying what workers are worth, they are obliged - by law, union agreements, and custom - to "take care" of employees instead.

Let's say a firm pays an average salary to employees of $50,000, with benefits that the employees may or may not need costing $10,000 for a total of $60,000. The firm employs 200 workers, so these costs amount to $12 million, of which $10 million is salary and $2 million is benefits.

Now, what if everyone got paid what they were worth, and with that money they provided for their own health care, retirement savings, etc. Then, they would receive $60,000 in take-home pay. But the employer is instead committed to spend on these things on the employees' behalf.

So let's say the firm is struggling and needs to cut $1.2 million. If employees were paid $60,000 (no health care, FICA, etc), then the firm could cut pay across the board by 10%, leaving people with salaries of $54,000, which is painful but better than nothing. And employees would be free to choose where to cut their own budget - such as savings and insurance - in order to maintain present consumption.

But as it is, each employee has on average $10,000 in employer-paid benefits. So if the company is determined to keep everyone on but with pay cuts, employees would have to take a 12% paycut from their $50,000 salaries, to $44,000. That's a much steeper hit on present consumption, and employees are less free to cut down on health care and retirement savings to maintain it.

And this estimate of a worker's worth going into "benefits" he can't control is probably low in the real world.

Indeed, wages for the Big Three Automakers are about $28/hour, with benefits approximately $10/hour - and the cost of taking care of retired workers is about $25/hour. What would wages be if the Big Three always and only paid their employees in wages, and let them take care of their own health and retirement? Probably $38 or more, while the cost of taking care of retirees would not be present in the cost of vehicles.

The more employees make, the more reasonable it is to ask them to take pay cuts (or reduced hours). The less they make - and the more is put in for "benefits" - the less reasonable it is to ask for pay cuts and the more likely it is that the company will just lay off workers.