Wage reductions in a downturn

Robert Peston raises the old chestnut about wage reductions. According to neoclassical theory, wages should reduce in a downturn as workers realise there is less demand for their services and cut the price accordingly. In the case of Corus and JCB, two British manufacturers, this is exactly what is happening - the unions have proposed a 10% wage cut in order to prevent plants from closing altogether.

However, adjustment rarely happens this way and there are some competing explanations for this - game theory and anchoring being the top two.

Here is an article from the Economist giving some of the alternative viewpoints.

But I would add two things:

1. Despite what Robert Peston says, the MPC was probably right not to assume this would happen. It would never have taken place if the union and workers were not immersed in the conversation about the savage recession we are expecting.
   
2. Wage stickiness has a positive economic effect - both to combat deflation and also to maintain gross demand. It helps to force employers to reduce their saving, acting as an automatic stabiliser in a downturn. Therefore this cut is not necessarily a good thing (I realise that there are positive aspects to it too - it is not clear to me where the balance lies).

Update: Corus is now asking the government to consider subsidising its wage costs in the short term - based on a Dutch scheme which aims to avoid the destruction of valuable company-specific skills through layoffs. My feeling is that this is a role for an equity investor rather than government. At most, perhaps government might be persuaded to share some of the benefits of continuing to get income tax revenue, or avoiding unemployment benefit. It feels like a slippery slope.