How Selective Are Real Wage Cuts? A Micro-Analysis Using Linked Employer–Employee Data

Existing evidence suggests that workers face a low risk of experiencing a real wage reduction. However, there is so far virtually no evidence whether some employee groups are affected stronger by wage cuts than other groups. Insider–outsider and several branches of efficiency wage theory predict selective wage cuts especially for employees who are less important for firm performance, whereas some recent contributions discard selective wage reductions and stress fairness considerations instead. In this paper, we investigate whether employers who (have to) reduce real wages do so in a selective manner. Using German linked employer–employee panel data for the homogenous group of young workers in the first five years of their first job, we fit linear models for individuals’ probability of experiencing a real wage cut. We include plant fixed effects that control for permanent differences in plants’ wage policies. We find clear evidence that plants resort to selective wage reductions. Medium-skilled and especially high-skilled workers are less likely to face a real wage reduction than low-skilled workers. The same holds for workers who have just recently been hired. Adding workers’ wage residual estimated from an extended Mincerian wage regression for the previous year as a measure of unobserved worker performance, we further find that workers with a higher residual have a significantly lower incidence of real wage cuts. Notably, the very same selectivity pattern shows up when restricting our analysis to firms covered by collective agreements or having a works council. Our finding is clearly in line with insider–outsider and several branches of efficiency wage theory. It is at odds, however, with fairness considerations pressing employers to selectively reduce wages such that wage dispersion among peers is reduced. We thus conclude that real wage reductions, though rare in general, are specifically aimed at those groups of workers who are less crucial to firm performance.

Hirsch, Boris and Thomas Zwick (2013), How Selective Are Real Wage Cuts? A Micro-Analysis Using Linked Employer–Employee Data, ZEW Discussion Paper No. 13-086, Mannheim, published in: LABOUR: Review of Labour Economics and Industrial Relations.