It’s a gamble that layoffs are better than changes to wages | UNB

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JDI Roundtable on Manufacturing Competitiveness in New Brunswick

It’s a gamble that layoffs are better than changes to wages

Herb Emery

Federal and provincial governments are working hard to get households and businesses through the severe coronavirus economic disruption. The Canadian Federation of Independent Business nonetheless reported a grim prediction of the immediate small business liquidity crisis turning into an irreversible insolvency crisis within weeks.

To address this acute economic crisis the federal government announced a time-limited 75 per cent wage subsidy and access to low-cost loans and credit to help businesses keep the lights on for a few months. For workers who lose their jobs or who fall ill, there is employment insurance, emergency cash transfers to pay bills and potentially some relaxation on mortgage payments, rents and maybe some other bills … for a few months. Two weeks ago these efforts looked like a $50 billion addition to budgeted deficit spending but now it looks more like a $200 billion increase for 2020.

As heroic, bold and necessary as the growing government bailout of “main street” is, it does not address the bigger problem coming from a prolonged COVID-19 economic disruption. William Watson of McGill University pointed out that governments don’t have the capacity to maintain this level of bailout spending for long. That means true recovery will come from a more difficult adjustment to wages and labour compensation.

If we can’t negotiate that adjustment, then recovery will be slow as it was in the 1930s if recovery occurs at all.

What local, provincial and federal governments are doing right now is known as “public relief” – short term initiatives intended to get households and businesses through a temporary disruption. It’s similar to “disaster insurance,” paying for the one-time costs following a rare event like an earthquake. This makes sense if the economic downturn is expected to have a “V” pattern where recovery is swift once business-as-usual conditions return.

The public relief approach has a long history in Canada. In 1929 as the Great Depression began, relief was largely the responsibility of municipalities. As the demand on local relief rose in the early 1930s, provinces picked up more of the relief responsibility as local government indebtedness grew and property taxes went unpaid. When relief expenses threatened to overwhelm the provinces, the federal government eventually bailed them out.

Municipal relief financed through the local property tax base was never capable of addressing prolonged unemployment of as much as one-third of the workforce in the 1930s. The solution to that problem was the 1940 introduction of federally administered unemployment insurance (UI) which was rebranded in 1996 as employment insurance (EI). UI was intended to be a fiscally sound way to address a short-term drop in labour demand with dedicated revenue from premiums, and stated benefits with rules for claiming. Other than seasonal workers, EI remains a time-limited form of income support. Once benefits are exhausted, and in the absence of a return to work, an individual will move to provincial social assistance, our modern version of the old “municipal relief” system.

The pandemic will strain the EI system. Last week, instead of the usual 45,000 EI claimants per week there were one million. There are forecasts that if the pandemic economic disruption lasts months, then our relatively low unemployment rates could more than double to almost 15 per cent. That’s as bad as New Brunswick had in the 1980s.

Workers and employers in Canada have pre-paid for this extraordinary wage and income support over the past 25 years. There should be a massive EI “rainy day” fund because the federal government has collected surplus EI premium revenue for some time (rather than reducing the premium to match revenues to claims expenditures). In 2001, the EI surplus had accumulated to $50 billion in today’s purchasing power and reached $66 billion in 2010. Then the Harper government transferred the full EI account balance to general revenues. The EI program has persisted in generating surplus revenues since 2010. However, the EI surplus will not get us far should the downturn be prolonged beyond a year.

Meanwhile, there really isn’t any insurance scheme for business income. If their revenues fall, business doesn’t (easily) get a break on property tax, insurance, energy or other fixed costs that they incur. When revenue falls, we collectively prefer that businesses adjust their payroll through changing hours of work or numbers of employees rather than reducing wages.

Indeed, this is why we need a wage subsidy of 75 per cent to keep employers from resorting to layoffs where possible. One explanation for this preference, I learned in graduate school, is that it protects workers from businesses lying about their profitability to gain advantage through wage or tax cuts. Employees prefer that their employer proves hardship by bearing the cost of laying off workers or going out of business so that they don’t have to unnecessarily give up any of their income.

This suggests that we collectively prefer to have a labour market lottery where some of us keep our jobs with full incomes, rather than see an overall wage drop that maintains a higher employment rate. We can live with the thought that someone else, whom we may not even know, lost their job.

Our preference for layoffs and business closures over wage adjustments is what will generate high unemployment if the COVID-19 disruption persists beyond the taxpayer’s capacity to support business payrolls.

When demand falls for what a business sells, the value of what an employee produces also falls. If wages can’t go down, then when revenue falls and the wages paid do not, the cost of labour for the business rises in relative magnitude. When the price of labour goes up, it’s the number of workers or hours of work that go down.

We need not have high unemployment if wages can adjust down when demand for what businesses sell is low, and rise again when competition for labour picks up with the economic recovery. If wages cannot adjust directly, though, we tend to require price inflation to erode the cost of labour. The “real wage” drops in terms of purchasing power, and labour demand rises as wage costs better align with the value of what labour produces.

If we face what happened in the early 1930s, price deflation, then labour costs will increase still more, resulting in even greater layoffs and even greater economic damage.

I know that it is too soon for these observations, given that we may start to come out of the COVID-19 economic disruption by June. Saint John Mayor Don Darling’s calls for a wage freeze went over poorly in his city. That suggests that for now, we are not ready to talk about planning for the consequences of a prolonged economic slump, and how to recover.

Instead, we will commit to large, short-term relief spending for disrupted employment income and low business revenues. We prefer to gamble that businesses and industry aren’t going to close or move somewhere else – and that they can keep wages and incomes at their current levels, or higher. We’d rather gamble than give up what feel like hard-fought income gains since the late 1980s.

But, if we lose that gamble, our preference for layoffs over wage adjustments will slow the recovery of the business sector. Persistent high unemployment dampens consumer demand and the recovery will look more like a droopy “U” than a sharp “V.” If businesses close, or exit the province, then the “U” becomes an “L,” and there is no recovery.

That is what happened in New Brunswick after 2008.

Can we afford to gamble?

Herb Emery is a Brunswick News columnist and Vaughan Chair of Regional Economics at the University of New Brunswick.

This article first appeared in Brunswick News publications – April 1, 2020

The JDI Roundtable on Manufacturing Competitiveness in New Brunswick is an independent research program made possible through the generosity of J.D. Irving, Ltd. The funding supports arms-length research conducted at UNB.