Handling The Impact of Recessions While Avoiding Severe Unemployment Costs

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Given the very slow and gradual economic recovery that the US is experienced, it’s important not just that we discuss policy changes (which will probably fall on deaf ears as politicians are more focused on positioning for the 2014 election than taking any action), but to try to develop alternative systems that politicians can support

In a Wall Street Journal option, A Nimbler Approach to Wages and Workers, Peter A. Coclanis suggested we look at different wage structures to help us ride out the impact of recessions: companies downsizing forcing people to need unemployment insurance benefits. One option is the European “flexicurity” system, a model championed by Denmark for two decades that combines flexible hiring policies with a generous social safety net. It’s the latter that makes this unacceptable in the US.  Another option is the German job-share model Kurzarbeit, where the government encourages employers to reduce employee hours during troubled times rather than laying off workers, by providing income supplements to the affected employees. This keeps employees on the job and saves the government money by not adding to the long-term unemployed. However, a large new government “transfer” program also is a nonstarter in U.S. politics.

A third option is worth considering: the flexible-wage model, which gives employers flexibility as economic conditions change. Singapore and other countries in Asia (e.g, Japan, South Korea and Taiwan) have experimented with techniques based on this model for decades, with considerable success.

Since 1986, Singapore has used a scheme that is two-tier in the sense that it divides wages into two broad components: fixed and variable. The fixed is the larger of the two, particularly for wage workers, and doesn’t change year-to-year. But the variable component is often broken down into several discrete parts, including an annual bonus and a monthly adjustment. This gives the employer a contractually negotiated amount of flexibility. Firms can adjust wages annually, biannually or even quarterly depending on market conditions, allowing companies to respond more nimbly to changes in the market, the firm’s profitability, or other concerns.

When a company endures a downturn, for instance, it can respond quickly by adjusting wages downward without cutting hours, laying off employees or calling in the government. Companies can also raise wages in good times of strong growth, higher profits or other favorable events.

This system isn’t perfect, and the devil is in the details. How much variability makes sense? Is 10% too little flexibility? Is 20% too much? How are recalibrations to be determined? What about monitoring? How will disagreements over recalibrations, should they occur, be arbitrated? Can such a scheme be implemented in a cost-effective manner? Singapore and other Asian countries have found reasonable answers over time. Singapore’s unemployment rate is a mere 1.8%, and averages at 2.5% over the past 25 years. That’s significantly lower than the unemployment rate in Sri Lanka (4.2%), Indonesia (6%) and New Zealand (6.3%), all of which do not use flexible wage systems. Other factors are at work, but wage-flexibility no doubt helps.

The U.S. is not Singapore. But a flexible wage-system is worth considering because it could keep people employed, and enhance the nimbleness of firms still struggling amid slow economic growth.

What do you think? Share your thoughts!