The Sticky Wage Theory is an economic hypothesis that describes how the pay of employed workers tends to respond slowly to changes in the economic environment. Employers are slow to increase wages during an economic expansion, so as to not get caught off guard by a subsequent downturn. On the flip side, wages tend to adjust slowly during an economic downturn as well. While some workers are laid off, the wages of those who are able to keep their jobs will often remain flat, or continue to grow at a slower rate than before.
While there are different schools of thought, many economists believe that wages are particularly sticky on the downside. In other words, it is easy to give someone a raise, but it is much more difficult to take that raise away.
I spend a fair amount of time talking with the offspring of clients about general financial concepts. Most of the time, these are young adults who are in college or have recently graduated and are tasked with finally being out on their own financially. In almost every one of these discussions, I touch on a slightly modified version of the Sticky Wage Theory. I call it the Sticky Spending Theory.
The Sticky Spending Theory goes something like this:
It is very easy to become accustomed to a higher standard of living. At the same time, it is exceedingly difficult to revert back to a lower standard of living once you’ve ratcheted up. One’s cost of living tends to be very sticky on the downside.
Most of us can remember a time when we really didn’t need much to get by. In college, my expenses consisted of gas for a 10 year old car and $50 per week for food. I was perfectly content at the time, but it would be awfully difficult for me to go back.
I find this topic particularly helpful for those who are in their teens, twenties, and even thirties, because their highest earning years are usually ahead of them. If they are able to budget wisely, they have the ability to build toward and maintain a very comfortable lifestyle. If they get ahead of themselves, they may become painfully aware of just how sticky a higher lifestyle can be.
All comments and suggestions are welcome.
Christopher W. Frayne, CFA®, CFP®