Sectoral Differences in Wage Freezes and Wage Cuts: Evidence from a New Firm Survey

Downward rigid wages are of major importance in economic policy and are severely discussed in the public. Especially in Germany, where the nominal wage level is above that of its main international competitors, economists often recommend to freeze or lower nominal wages, at least in adverse economic conditions. This study first analyzes how often nominal wages are frozen or cut. Wage cutting appears as a rather rare event. Over a five year time span, only about 16% of firms in manufacturing and 13% of firms in services ever cut their wages. Compared to wage cuts, wage freezes are much more frequent. They occur three times as often as wage cuts in manufacturing, and more than four times as often in services. Taken together, the evidence suggests that German firms have become quite flexible in the last five years to adjust at the wage margin when poor business conditions required it. Wage freezes are more frequent in services than in manufacturing, whereas wage cuts are less frequent. These significant sector differences do not vanish if one controls for individual firm characteristics influencing the incidence of wage freezes and wage cuts, notably coverage by collective agreements and the degree of price competition on the product market. Which reasons prevent the firms from cutting their wages? In case of wage cuts, three-fourths of the employers fear the decreasing morale and the poorer effort and/or service of their employees. Additionally, about 60% of firms refer to labour legislation and 40% to collective wage agreements. The key difference between the responses of manufacturing and services appears in the realm of worker turnover. One third of firms in services fear increasing quits and excess worker turnover. This reason could explain fewer wage cuts in services. According to our empirical estimates, this argument is mentioned much more frequently by services firms than by manufacturing firms, even after accounting for the differences in relevant firm characteristics. The sector specific effect probably reflects the fact that actual worker turnover rates in services are much higher – more than twice as high, in our data – than in manufacturing. The survey includes a wide range of services. Therefore, within the service sector the incidence of nominal rigidity broadly varies. Wage freezes are most frequent in the IT sector where the relevant labour market is generally very flexible, and least frequent in real estate activities. Results for wage cuts are the same, as the latter occur most often in the IT sector and quite rarely in real estate activities.

Bonin, Holger and Daniel Radowski (2008), Sectoral Differences in Wage Freezes and Wage Cuts: Evidence from a New Firm Survey, ZEW Discussion Paper No. 08-097, Mannheim.