Back To Compensation Today

How to Survive a Recession: Should You Freeze Pay or Reward Performance?

We’re not officially in a recession yet, but the writing is on the wall. A recession is defined as two consecutive quarters of negative economic growth and it has barely been two months. Still, with five consecutive weeks of record-breaking unemployment numbers and no clear determination on when business will get back to normal, every organization is asking how to survive a recession.

The rise in unemployment has been momentous. In January, the unemployment rate was 3.5 percent and celebrated as a 50-year low. In February, the economy began to tremble as social distancing was enacted. In March, with the first announcements of layoffs, the unemployment rate rose to 4.4 percent. And then came April, when waves of layoffs rippled across the country. How to survive a recession has since become a core and ongoing business concern.

unemployment rate - april 2020

The Congressional Budget Office (CBO), which provides nonpartisan analysis for the U.S. Congress, is now predicting that the unemployment rate will be 16 percent by Q3 and that even if businesses start rehiring, that unemployment may remain as high as 11 percent in Q4 and possibly throughout 2021.

Learn More About Our Compensation Software


 

Although nothing is certain, these are sobering numbers. 11 percent is one percent higher than the unemployment rate during the worst period of the Great Recession in 2007-2009. However, despite what some media outlets are saying, the unemployment rate is not at Great Depression levels — at least not yet. The current situation is also very different from the Great Depression. Estimates place the unemployment rate during the height of the Great Depression in 1933 at 24 or 25 percent. The New York Times estimates that the unemployment rate so far for 2020 is around 13 percent.

Great Depression Unemployment Rate Compared to 2020 CoronavirusStill, unemployment in the low to mid-teens is the worst we’ve seen in almost a hundred years. In order to survive a recession of the magnitude that the present-day slump in economic activity is predicting, businesses are shoring up their finances, tightening operations, analyzing their expenses, and looking at their options when it comes to headcount and managing employee pay.

What Happens to Wages During a Recession

The biggest expense that most businesses manage is payroll.  It is therefore unsurprising that, in addition to layoffs, many organizations are considering — or implementing — pay freezes or pay cuts in order to survive the current economic climate and prepare for a coming recession. This means no raises and potentially reducing compensation for employees. Wages and salaries for new hires are also reduced.

The impact of this is slowed wage growth, meaning that people will earn less than they would have if there wasn’t a recession, which can be felt for years after the recession has ended.

Analysis on the Employment Cost Index from the U.S. Bureau of Labor and Statistics (BLS) shows that reductions in wage growth and salaries are typical during recessions and also continue into post-recession recovery. Before the 2007-2009 recession, wage growth was 3.6 percent. In December of 2009, wage growth had slowed to 1.3 percent.

We expect — and are already seeing — something similar happening now.  PayScale also measures wage growth data in our PayScale Index Report. Our data show that wages grew 2.3 percent in Q1 compared to last year and 0.5 percent compared to the previous quarter.

Given the speed that the coronavirus has caused the economy to tumble, we are now analyzing this data monthly with year-over-year analysis showing the percent change in wage growth by industry, occupation and major metro cities. In comparing February to March 2020 industry data, we found that the average wage growth declined -0.7 percent.

Although fluctuations month over month are common throughout the year and are impacted by more than just the coronavirus pandemic and the affects of social distancing, analyzing wage growth data can still be illuminating and help organizations with their compensation planning.

Interested? Get our latest report on The Impact of the Current Economy on Wage Growth.

But what does this data mean? What should you do? If wages are slowing for your industry, should you freeze pay? Or is it still important to reward performance?

How Compensation Management Can Help You Survive a Recession

The fact that wage growth has declined into the negatives — at least for some industries and occupations — may lead you to conclude that merit pay freezes or pay cuts are a smart decision in keeping with what other organizations are doing to survive the recession.

This may be true, or it may be unavoidable, depending on your industry and particular situation. There are no simple answers, and certainly no one-size-fits-all solution when it comes to managing pay and recession planning. However, merit freezes and pay cuts can do more harm than good and shouldn’t be a knee-jerk reaction to survive a recession.  If you want to thrive in the coming boom, you should consider the impact, especially if your inclination is to freeze merit increases or cut pay unilaterally across the organization or according to changes in the market that may be too volatile to trust just yet.

If merit pay freezes and pay cuts are your answer to how to survive a recession just because you think everybody else is doing it, you might want to consider the following:

1. The Bigger Picture

Focusing only on how to survive a recession is myopic. Many organizations become defensive in an economic downturn and go into crisis mode, scrambling to reduce headcount and preserve as much cash as possible. These measures may be necessary, but a focus on cost cutting alone can shrivel the business to a degree that inhibits its ability to compete.

In 2019, the Harvard Business Review released research on How to Survive a Recession and Thrive Afterward that analyzed why some companies flourished during or just after the recessions of 1980, 1990, and 2000. Among other things, companies that saw the most success combined defensive actions, such as reducing payroll and improving operational efficiency, with offensive actions such as developing new markets or investing in new assets.

In other words, you should also be thinking about what happens after a recession. The objective isn’t just to survive. Ideally, you want to position yourself for breakaway performance after the recession ends.

On average, recessions last about 18 months, or 1.5 years. A depression lasts longer (the Great Depression lasted almost a decade), but the purpose of government stimulus and other legislation is to prevent a recession from becoming a depression. Assuming that the government will do everything in its power to hasten economic recovery, you should plan — at least initially — on an economic slump lasting one to two years.

Although the current situation is unique, and a coronavirus-related recession may last longer than a typical one, nothing lasts forever. A future economic upturn won’t be immeasurably far away.

2. The Impact on Morale

Pay freezes are sometimes unavoidable but need to be considered in context of their impact on workforce productivity. Employees’ livelihoods depend on their pay and their self-worth — as well as their perceived value to the business — is also tied to their compensation. Lowering pay in particular can communicate to employees that they are not valuable. This is especially true if pay is cut unilaterally across the board without any examination of merit or performance. Pay freezes can also demotivate employees, as no longer being eligible for a raise defeats the purpose of working harder or taking on any additional risk, especially for younger employees newer to the workforce who should be growing rapidly.

The Harvard Business Review also examined the impact of atypical strategies to reduce the burden of payroll that did not involve pay cuts or layoffs, such as offering shorter work weeks or reduced hours in exchange for reduced pay. This strategy lightens the load on the business while giving employees something in return that doesn’t devalue what they are worth. Furloughs and short-time work options also give employers discretion over which employees are affected, which allows them to consider merit and performance. Unilateral pay cuts do not offer this option.

In summary, failure to consider the productivity and recent growth of individual employees can drive the organization’s top performers to leave the organization as soon as they can secure a better paying position.

3. Your Compensation Strategy

These considerations only demonstrate the importance of having a compensation strategy. Ideally, your compensation strategy is closely aligned to your business strategy and outlines how you intentionally use compensation to attract and retain the talent you need to compete in the market.

If you have compensation structures in place, you will be able to more easily analyze the impact that pay freezes will have on payroll, should you be forced to make those choices. You will also be able to more easily communicate your new compensation strategy to your workforce. As we’ve seen time and again, pay transparency and pay communications increase employee engagement and morale.

If you don’t have a philosophically-informed compensation structure, a recession might be a good time to develop one. A time of crisis can be a strong catalyst for engaging in strategic projects that have been put off previously and can make a difference in how your employees engage and how the business performs when the economy picks up.

4. Pay for Performance

Pay for performance can be both a defensive and offensive strategy to help you survive a recession while also providing motivation to your employees to bring you their best.

In order to adjust pay based on performance, you have to track performance, which is commonly done through some kind of rating system (i.e. scores of 1-5 tracked over time). If you also have compensation structures in place (pay ranges and grades for your jobs), you can use compensation management software to create a dashboard showing how employees are being paid according to their performance ratings. For example, you can see which employees have low performance ratings (e.g. a 1 or 2 on a rating scale) and whether any are red-circled (overpaid) or otherwise candidates for a pay freeze. You can also look at all employees with 4s or 5s to see if they are green circled (underpaid) or otherwise candidates for a pay bump.

Building out a modern pay-for-performance program that is tied to how you allocate merit pay increases, incentive pay, or otherwise reward employees for superior work can then be used to motivate your employees to focus on results and contribute to the success of the business. Implemented properly, pay for performance programs can energize a workforce during a tough economic climate.

Conclusion

There are no rote answers when it comes to how to survive a recession. The right strategy depends on your business — the size, industry, debt, strategy, and many other factors.

However, the way to really succeed is to think about what comes after survival. Freezing pay and making pay cuts can be the right decision in some situations, but organizations should consider the negative impact to employee morale and the possibility that too many cost saving measures can hamstring the organization’s ability to grow when the pendulum starts to swing the other way.

The right solution should include a mix of both defensive and offensive actions. When it comes to compensation, offensive action may be to invest in pay-for-performance programs that can be analyzed against employee data to incentivize and reward employees who go above and beyond to help the business not only survive a recession but thrive afterward.


Do you want to know more about how the current economic climate is impacting wages? Download our whitepaper.

Curious to know how we are responding to the coronavirus pandemic? Check out our free data offering.

Want to learn how compensation software can help you track pay against performance? Request a demo.

 

Amy Stewart
Sr. Content Marketing Manager at PayScale
Read more from Amy

Leave a Reply

avatar
  Subscribe  
Notify of
Start the Transformation

We can help you bring modern compensation to life in your organization.