Sticky Wages

Wages are typically an inflexible production cost because the nominal wage is often determined by contracts and agreements signed at some point in the past. Even in non-unionized environments, where there are no negotiated wage agreements signed with employers, there are often informal agreements between employees and employers which may be difficult ro revoke or adjust.

In poor economic times, such as the current recessionary period, firms will be reluctant to reduce wages for fear of creating bad feelings with workers. Similarly, in good times, firms will not wish to raise wages lest they encourage workers to demand further increases, So, by their very nature, nominal wages tend to be sticky.

However, wages cannot be sticky forever. The length of time that it takes for nominal wages to adjust is what determines the short run from the long run. In the short run, wages are usually a fixed cost of production; in the long run, firms have the opportunity to adjust wages.

While wages tend to be inflexible, prices tend to be flexible. In imperfectly competitive markets, firms have varying degrees of power to set their own prices. In the current environment, where demand for many firms has decreased, firms will sell less product at a given price. Given this weaker demand, firms will try to limit the fall in demand by cutting prices. Because wage costs are fixed in the short run, this means less profit for a firm. Firms are then likely to further respond by downsizing or trimming capacity in an effort to reduce costs and boost profitability.

The above explanation helps us to understand two recent news items where two separate firms (Electro-Motive Canada in London, Ontario, a unit of Caterpillar, and Rio Tinto Alcan in Alma, Quebec)  are taking a hard-line in wage negotiations with their unionized employees.With the expiry of existing wage contracts, these firms have, in effect, ended their short run and entered their long run where wage costs can now be made, to some degree, flexible.

In the Electro-Motive case, Caterpillar is unilaterally imposing lower wages and benefits for its workers. Rio Tinto Alcan may move to do the same. These responses represent moves by each firm to revise wages downwards in the face of changed economic conditions. When the new wage rates are established, each firm respectively will enter its short run again.

Downward revisions in wages and benefits will always be unpalatable to workers, for obvious reasons. However, despite the animosity such moves by a firm may create, workers are likely to have limited power to address such moves when unemployment levels are elevated and replacement workers plentiful.

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