ORGANISATIONS have implemented pay freeze as an alternative to reducing headcount but a recent report from a UK research firm suggests that it may not be enough to prevent further job cuts. 

Despite their best efforts, companies like British Airways, the BBC, Ford, Freshfields and Southern Water who are considering or actually freezing pay may not be able to stop the oncoming wave of job cuts, said Capital Economics in a press release last month.

There are several reasons why pay freeze may not be sufficient and one of them is that current pay cuts may not be deep or wide enough, Capital Economics UK economist Vicky Redwood said.

To bring about equivalent cost savings through wage cuts, all 30 million or so workers in the UK would have to accept an average pay cut of 5%.

Secondly, whether employers freeze salaries or cut jobs, it would still result in reduced household earnings. Although this would lead to falling inflation, rising job insecurity would encourage people to save money rather than spend it, said the report.

Redwood expects retail price index inflation to drop to below -3% by autumn and to average less than -2% in 2009 as a whole.

Even so, real household disposable income in the UK is expected to rise by between 2.5% and 3% this year. The rebound would clearly be stronger if nominal pay growth were not slowing. The deterioration in the labour market is likely to be a key factor ensuring that this extra money is saved, rather than spent.

Capital Economics said in another report on the same day that the number of unemployed in the UK for the last quarter (4Q) increased by 146,000 to 1.97 million, marking an 8% increase from the previous quarter.

However, the usual time lags between economic activity and the labour market mean that the sharp 1.5% contraction in gross domestic product in 4Q is yet to be fully reflected in the unemployment figures. Redwood feels that International Labour Organisation unemployment figures will reach 3.5 million or 11% by the end of 2010.

In the US, the number of people in full-time employment between November 2007 and January 2009 fell by 6.1 million (5%) from 121.9 million to 115.8 million, according to the Bureau of Labour Statistics’ Current Population Survey.

In some respects, pay cuts could actually be worse for the economy than job cuts, said Capital Economics. Pay cuts are likely to affect consumers’ price expectations more directly and could therefore kick off a downward wage-price spiral rather more quickly.

The YouGov/Citigroup measure of the public’s inflation expectations over the next 12 months dropped from 4.4% in September to just 1.1% in December. About a quarter of respondents expect inflation to fall below zero over the next year.

Capital Economics feels that average earnings growth will slow sharply over the next year or two, as inflation falls and a large amount of slack in the labour market opens up.

But this is unlikely to prevent a major jobs shakeout at the same time, it said. The prospect of a major shakeout in the jobs market remains a key reason why banks are likely to remain cautious about lending to households and why the research firm doubts that the recession will be over by the end of this year.