Downward wage rigidity is indeed an important feature of the economy. Studies of general wage increases in manufacturing, union contracts, employer surveys, and our own phone survey of workers allows us to directly examine whether wage cuts are frequent. These data show that wage changes vary across firms, yet few employees receive wage cuts even when inflation is low. Many receive wage increases and many no wage change at all, but the distribution is abruptly truncated at zero. However, though 47 percent of workers received no general increase in that year, less than one-tenth of one percent of workers were employed by firms that made general wage cuts.
Firms are extremely reluctant to cut workers' wages.
Instead, they compute these changes from wages reported by workers in surveys taken a year apart. The problem is that survey data of this type is rife with error. A recent study by John Shea of the University of Maryland matched a number of people in one of these survey studies with their union contracts. He found that though 21 percent of the wage changes computed for these survey respondents showed declines, only 1.3 percent actually had wage declines in their respective union contracts. Using direct evidence on survey response error, we have shown that the typical errors from panel surveys are easily large enough to produce the appearance of frequent wage cuts, even when the true distribution of wage changes has no such cuts.