EconLog posted one of their most informative posts today. Bryan Caplan writes on why wages do not decrease during a recession (i.e. why employers favor layoffs). Markets in everything. It appears that there is an internal business market for equity among workers. Workers expect raises, and moral suffers when there are none or when the reverse happens. Whereas layoffs are passing inconveniences to those who retain their job, a pay decrease would cause a productivity drop even in those who are able to keep their jobs:

Question: OK, so why don’t nominal wages fall for given workers at given jobs?

Answer: Because almost all employers realize that nominal wage cuts are terrible for morale – and bad morale is bad for worker productivity.

Question: Why don’t they cut wages, then fire workers who slack off?

Answer: Because labor productivity heavily depends on trust and reciprocity. Firing can deter specific offenses, but can’t make workers broadly promote their employers’ interests. Plus productivity is much easier to observe at the group level than the individual level.

Question: Why don’t they cut wages, then fire workers who slack off?

Answer: Because labor productivity heavily depends on trust and reciprocity. Firing can deter specific offenses, but can’t make workers broadly promote their employers’ interests. Plus productivity is much easier to observe at the group level than the individual level…

Question: Doesn’t this suggest that the better-paid employees were underpaid?

Answer: Absolutely. Internal horizontal pay equity norms depress pay for good workers and inflate pay for bad workers.

Question: Is that the whole story?

Answer: No. Lay-offs are bad for morale if they drag on, or if workers see no light at the end of the tunnel. But a big quick wave of lay-offs, followed by reassurances of job security for everyone remaining, only hurts morale for a few weeks or months. Many employers sweeten the deal by using the cost savings of lay-offs to fund raises for remaining workers!

The whole post is worth a read. When leftists claim that businesses are only in business for profit, it should be understood that the businesses are forced to play the juggling act of worker productivity, equity, morality, reputation and profit. While they care about profit, they are forced to consider what workers believe is right and fair. The wages that are set are not arbitrary, and, as the text states, sometimes more productive people are harmed because of the moral values of equity of their less productive counterparts.