Is it better to lay off some workers or pay all workers less?

Companies routinely lay off workers during a downturn in the economy. At first glance it seems more rational to try and renegotiate labor contracts with existing workers and push down wages rather than lay people off.

That is until loss aversion takes hold and employees retaliate for being paid less.

A series of studies in the burgeoning field of behavioral economics provide some insight into why managers seem to prefer handing out pink slips rather than lowering salaries.

From Slate:

In one recently released study, which arguably stretches the bounds of what can be (ethically) done to human subjects, temporary employees signed on to sell nightclub entrance cards on the street in two German cities. The sellers worked in pairs, covering two shifts over the course of a couple of weekends, and were told they'd be paid 12 euros an hour.

After the first weekend's shift, some of the workers were told—with no explanation—that they'd receive a 3-euro wage cut. Workers retaliated by selling 15 percent fewer cards in their second eight-hour shift, compared with a group of control employees who kept their 12-euro wage rate. Evidently, the sting of lower wages doesn't fade so quickly with time. (For a third group of employees, only one worker in each pair got a wage cut, again with essentially no explanation provided, beyond the manager's whim. In this case, the lower-paid worker sold 30 percent fewer cards.) So it seems bosses are smart not to cut wages.


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