Will Paychecks Shrink in 2011?

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Workers expecting a raise in the next year, might get something very different–a pay cut.

Wages have already been growing very slowly during the recession, up just 1.5%. That’s down from 3.5% at the beginning of the recession. And when you factor in inflation, real wages, which is the measure of whether you can buy more or less stuff with your paycheck, are basically flat. But is the pay picture set to get worse? Perhaps. As growing number of the 14.5 million Americans looking for a job re-enter the workforce, the pressure on wages might cause salaries to fall for the first time in decades. Here’s why:

Wages typically don’t fall, even in recession. Workers don’t like to get paid less. And employers are usually worried about the morale issues of cutting pay. So they don’t. And that’s what happened in the past few recessions, and this time around as well. At least so far. What’s changing is that the unemployment rate has stayed high much longer than in past recession. It’s been above 9% for 20 months and, despite dropping in December, is likely to stay there for most of 2011. What’s more, nearly half of the unemployed–6.4 million–have been out of work for more than 6 months. The longer someone is jobless the more likely they are to work for less.

A new report from the Bureau of Labor Statistics shows that more than half of all workers who have been laid off during the recession from jobs that they held for more than three years took a wage cut when they landed a new job. In many cases the difference was significant. Nearly 40% of all workers who got new jobs said their paychecks were at least 20% lower than what they used to earn.

So far hiring has been very light. But as the job market picks up more and more people will be landing jobs at salaries much less than they used to get paid. And their willingness to work for less could end up pulling down wages for everyone. There are currently 139 million people in America with jobs. The average estimate is that the economy will add 2 million jobs this year. If half of those workers come from the long-term unemployed, based on the recent BLS report, more than 500,000 workers next year will take a pay cut. And 80% of those will accept jobs paying 20% less than their previous employment. That’s not enough to cause wages to fall, even with pay only rising 1.5% a year. And the tax cuts, by dropping social security taxes two percentage points, pretty much ensured that all workers this year will see their take home pay rise. But it’s likely that by this time next year, workers would be to willing to take even less than 20% of what they used to get paid. In the 1980s recession, the average pay drop of someone who was part of a mass-layoff was 30%. Take away the tax cuts, and take home pay is all but sure to drop in 2012, that is if the economic recovery remains weak.

All that is to say that the likelyhood of falling wages has never been greater. Tyler Cowen, an economist at George Mason University and a blogger, recently asked his readers if they expect wages to drop? One person responded 100%. Wage deflation if it occurred would be a real problem for the economy and individuals. The problem is while prices and wages can drop, debts tend not to. So workers have to make the same mortgage payments with fewer dollars. Foreclosures ensue. The Federal Reserve policy makers at its most recently meeting concluded that the threat of deflation was receding. We may not be out of the woods yet.

Downturn’s Ugly Trademark: Steep, Lasting Drop in Wages (via WSJ)