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Pay freezes make workers just as unhappy as pay cuts

April 04, 2003

Pay freezes make workers just as unhappy as pay cuts, according to new research by University of Warwick economist Dr Jennifer Smith, to be presented at the Royal Economic Society's Annual Conference on Tuesday 8 April. But her research also shows that happiness (both satisfaction with pay and overall job satisfaction) is strongly affected by factors other than pay. In particular:

* Older people are generally happier.

* Educated people are typically less happy.

* Women are happier than men.

* Black and Asian workers are less happy than their white counterparts.

* Workers lucky enough to have a source of income apart from their jobs are happier than those who rely only on their pay.

* Poor health has a large negative impact on happiness.

The research also compares happiness across occupations, industries and regions. It shows that:

* The workers happiest with their pay during the 1990s were Managers in the Energy and Water Supplies industries in Yorkshire and Humberside.

* Those least satisfied with their pay were Plant and Machine Operatives or workers in the Distribution, Hotels and Catering Industries, located in Wales, Scotland or Greater London.

The main aim of this study is to discover the effects on a worker's happiness of a pay rise, a pay freeze and a pay cut. The research confirms that a pay rise makes workers happier. Correspondingly, workers who suffer pay cuts are on average 8% more likely to report themselves dissatisfied with their pay, compared with other workers who don't experience pay cuts. They are also 10% less likely to report themselves satisfied with their pay.

Psychological studies, often carried out in laboratories, had suggested that workers might suffer a steep drop in happiness after seeing their pay fall in money terms. In particular, workers might suffer from what is known as 'money illusion'. A pay freeze, implying no reduction in the money value of the pay packet, would be much preferred to an actual pay cut in nominal terms - even if both were associated with a fall in the real value of workers' pay. (This idea has been used by labour economists to explain why we see so few pay cuts, even when the alternative is layoffs.)

This research finds that pay freezes are not well regarded by workers. Workers taking pay freezes are significantly less happy than their counterparts enjoying rises, and in fact seem no happier than those suffering actual pay cuts. This research therefore does not support the notion of 'money illusion' (which is essentially an 'irrational' psychological effect). The findings suggest that workers might be rational enough to realise that there is little difference between a pay freeze and a small pay cut.

The research uses information from around 6,000 individuals in the British Household Panel Survey, who were asked about their pay, their happiness and other factors, each year between 1991 and 1999. Only individuals who did not change job were selected (known as 'stayers') in order to isolate the effect on happiness of pay changes, which means holding job conditions constant.

Warwick, University of