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Monday, 12 August 2013

The sense and nonsense of wage reduction

Today, there was news that might be shocking to some of us, but hardly surprising: the United Kingdom, Portugal, Greece and The Netherlands are among the countries with the sharpest drop in wages.

This could be found in the report of an investigation by the House of Commons library, summarized by the BBC. Here are the pertinent snips of their report:  

The value of UK workers' wages has suffered one of the sharpest falls in the European Union, House of Commons library figures have shown.

The 5.5% reduction in average hourly wages since mid-2010, adjusted for inflation, means British workers have felt the squeeze more than those in countries which have been rocked by the eurozone crisis including Spain, which saw a 3.3% drop over the same period and Cyprus, where salaries fell by 3% in real terms.

Only the Greeks, Portuguese and Dutch have had a steeper decline, the analysis showed, while in Germany hourly wages rose by 2.7% over the same period and in France there was a 0.4% increase.

Across the EU as a whole the average fall in wages, adjusted for the European Central Bank' s harmonised index of consumer prices (HICP), was -0.7% and in the eurozone area it was -0.1%.

I called the outcome of this investigation hardly surprising, at least for The Netherlands, as the writing had been on the wall for quite some time (see for instance this and this article). As a matter of fact: my own salary and that of my colleagues has been involuntarily reduced to save my company’s bacon.

Looking at wage reduction objectively, you could state savely that reducing wages helps companies to lower their expenses and thus increase their profitability. In cases where the sheer survival of a company is at stake, like at my own employer, a wage reduction COULD be justifiable. In this case, it makes sense.

Nevertheless, a general wage reduction in a country – like the ones detected by the House of Commons library – has a devastating effect on the purchasing power of people and consequently on their consumer confidence. You simply don’t spend your last dime on consumption goods and durables, if you suspect that your next pay check could contain (much) less money.

It might be a tell-tale signal that the consumer depression in The Netherlands is about the worst in whole Europe, in spite of the fact that it is one of the richest countries in Europe. 

Another psychological side-effect of wage reduction is that people feel less valued by their company and lose their motivation at their work. Eventually people could become really depressed, when they see that their employers ask for wage reduction, while the profitability of their companies remains at very high levels and the remuneration of executive management increases, like it always does.

And there are other undesired side-effects:
  • Companies that reduce their expenses through wage reduction become less innovative and strong, as the need for innovation diminishes with the reduced expenses.
    • The same is true for countries too.

  • Often the worst led companies choose for the path of wage reduction first, as they are often clueless about improving their business models and – in the process – earning more money.
    • This is also applicable to whole countries. Look for instance at the innovational power of Germany and France vs the United Kingdom, The Netherlands and Greece.

Especially these last two side-effects should not be underestimated. Germany and France (although especially this country had its fair share of economic headwinds over the last twenty years) have always opted for a strong and innovative manufacturing industry, which brought and kept their countries in the forefront of innovation.

While both the United Kingdom and The Netherlands still are home to many innovative companies, it can’t be denied that their political leaders have largely neglected the manufacturing industry in these countries over the years.

This happened in favor of transport and distribution (The Netherlands) and (financial) business services (The Netherlands and especially the United Kingdom): both T&D and FinBuss Services are industries where the rate of innovation is often low and the margin is therefore much tighter:

“if everybody can do what you do, than everybody is your competition”.

The wage reduction at one hand and the assignment of cheap labour from Eastern Europe and the Far East at the other can further accelerate the race-to-the-bottom, which increasingly suffocates innovation in the UK and The Netherlands.

To mention my own (beloved) employer once more: it was the lack of innovation and daring that almost killed my company over the last five years. The general wage reduction will certainly not spur innovation in my company: it will only postpone the seemingly inevitable.

Please remember: good companies invent new and improved products and services. Bad companies only save expenses and try to please the shareholders by giving presents.

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