Why Firms Avoid Cutting Wages

Abstract

Firms very rarely cut nominal wages, even in the face of considerable negative economic shocks. The authors of this article use a unique survey of 14 European countries to ask firms directly about the incidence of wage cuts and to assess the relevance of a range of potential reasons for why the firms avoid cutting wages. They examine how firm characteristics and collective bargaining institutions affect the relevance of each of the common explanations for the infrequency of wage cuts. Concerns about the retention of productive staff and a lowering of morale and effort were reported as key reasons for downward wage rigidity across all countries and firm types. Restrictions created by collective bargaining were found to be an important consideration for firms in Western European (EU-15) countries but were one of the lowest-ranked obstacles in the new EU member-states in Central and Eastern Europe.