Universal Pay Cuts May Lighten Recession

By Steven Pearlstein
Wednesday, December 31, 2008

The Teamsters are not generally known for being easy to push around, so it is of some interest that the union's leaders have struck an agreement to allow the country's largest trucking company to cut the pay of its union members by 10 percent to help the firm survive the economic storm.

As you might expect, the deal does not come without a price: In return, union employees will get warrants that will allow them collectively to buy 15 percent of the stock of YRC Worldwide. The company has also assured the union that similar pay cuts will be given to nonunion employees, including top executives.

The hard-nosed calculation made by Teamster officials is that, with YRC's financial viability at stake, it is wiser and fairer to spread the pain among all active workers rather than force the company to lay off even more workers, or refuse to take a cut and possibly force the company into a bankruptcy reorganization in which workers and retirees would likely take even bigger hits.

This idea is not a new one. Economists have long believed that the only reason there is persistent unemployment is because labor is unlike most other "goods" -- its price does not go down when the supply gets out ahead of demand in the early days of an economic recession. Without a reduction in the price of labor that can induce additional demand, it's much harder for the market to "clear" and put supply and demand back in balance, albeit at a lower wage level.

During the 1980s, Martin Weitzman, then an economist at Massachusetts Institute of Technology, suggested that recessions could be shorter and shallower if firms would do what YRC and the Teamsters have proposed: reduce pay and working hours for everyone just a little bit rather than place the burden of the adjustment process on a handful of workers. One way to accomplish such a "share economy," Weitzman argued, would be to change the structure of compensation so that a higher percentage of it was in the form of a bonus based on company revenues and profits, with a lower base pay. That would allow firms to reduce payroll costs during a recession without having to resort to big layoffs. It would also help ensure that workers shared in the boom times as well.

There was a time when I was quite enamored with this idea, and I still think it could be usefully applied in certain circumstances. The one that comes most readily to mind is the law.

You may have read that in recent years, the competition among major law firms to attract top talent became so intense that first-year associates were paid as much as $180,000, plus bonus, at the top Wall Street firms -- in some cases, more than federal judges make.

By any standard, it is a ridiculous amount of money. One reason the firms could afford to pay it is because corporate clients are billed at equally ridiculous rates of $250 an hour for greenhorns. The other reason is that the associates are expected to routinely put in 60 and 70 hours a week if they want any chance of making partner. The result has been a system that basically overcharges clients while leaving stressed and overworked associates feeling as if they are trapped in a gilded cage.

With the drought in deal flow and securities work, however, any number of these white-shoe firms have had to retrench. Underperforming partners are quietly being "de-equitized" (a euphemism for being kicked out of the partnership), associates have been laid off, offers of employment to new associates have been rescinded and summer programs for law students are being curtailed. In just the last few weeks, a number of firms have even frozen pay for associates at current levels.

The more interesting question, however, is why the firms haven't gone further and significantly reduced the pay of all associates, as well as the number of hours they are expected to work, along the lines of what the Teamsters and YRC have done. That way, firms could avoid further layoffs and perhaps even continue to hire a modest number of new associates. More significant, the plan might actually put an end to the arms race in associate pay and allow associates to get a life.

Undoubtedly, there would be some highly desirable law school students who would decide not to apply to a firm that dares to break from the pack and reduce associate pay. But given the high levels of dissatisfaction among law firm associates, it's a pretty good guess that there would also be a sizable number of top graduates from top law schools who would flock to a prestigious firm that offers a healthier trade-off between pay and lifestyle. It should tell you something about the legal business that no major firm has had the courage or the imagination to try it.

Trucking and the law are hardly the only industries in which a share-the-pain plan makes sense during an economic downturn. From a societal standpoint, it is certainly a fairer system and, as Weitzman's research indicated, it could reduce the severity of recessions. But as the law firm example demonstrates, it's hard to get any one company to embrace the practice unless everyone else is doing it because of the risk that the most valuable and productive employees will defect to firms that don't participate.

There is also a question of whether there isn't some long-term benefit to the economy from putting firms through the painful process of having to cut costs by cutting staff -- and then having to find new ways to do the same work more efficiently. It is no coincidence that the biggest productivity gains tend to be logged during the years coming out of an economic downturn, when companies that have been forced to run leaner and meaner suddenly have more work to do. And one of the great competitive strengths of the U.S. economy is the relative ease with which we create and find new jobs for workers who have lost theirs. A share-the-pain system could reduce that "creative destruction" quotient in American capitalism.

That hardly means we should welcome every uptick in the unemployment rate. What it does mean is that if we all benefit in the long run from a dynamic economy in which the burden of the adjustment process is focused on a small group of unemployed workers, then the rest of us have an obligation to provide those workers with a decent economic safety net in the form of unemployment benefits, health insurance, retraining programs and other public services.

Steven Pearlstein can be reached at pearlsteins@washpost.com.

© 2008 The Washington Post Company