How the money illusion distorts our sense of fairness

A company is making a small profit. It is located in a community experiencing a recession with substantial unemployment but no inflation. There are many workers anxious to work at the company.

The company decides to decrease wages and salaries 7% this year.

Sixty-two per cent judged the pay cut unfair.

In another version of the question, the community was said to have ‘substantial unemployment and inflation of 12% . . . The company decided to increase salaries only 5% this year.’ Now 78 per cent said this was acceptable. But of course the workers’ lot is almost identical in both versions. Getting a 5 per cent ‘pay rise’ when prices rise 12 per cent translates into nearly a 7 per cent cut in buying power.

One conclusion is that inflation is the Scroogish employer’s best friend. A similar principle applies to bonuses. It was judged acceptable to skip an annual 10 per cent bonus, but not to cut pay by 10 per cent for a year. (Wall Street employers, at the mercy of a volatile market, have long made use of this.)

Inflation is a pay cut wearing a party hat.

“Congratulations, you’re getting five per cent more.” Lovely. Prices rose twelve per cent, but never mind: there is a larger number on the payslip and perhaps a cupcake in the kitchen. The economic loss and the experienced loss are not the same creature.

Companies use this gap constantly. A subscription stays at £20 while useful features wander into a pricier tier. A packet keeps its price and quietly loses a few biscuits. Base pay remains untouched, but the bonus that had become part of everyone’s mental salary disappears. Nobody announces a cut, which is apparently meant to make the missing value feel less missing.

I do not think people are thick. Nominal numbers are visible and easy to compare; purchasing power, quality and bundled charges demand homework. Fairness is usually judged before anyone has built a personal inflation model.

That is why mathematically similar changes can create wildly different reactions. People care about what felt owned, which promise moved and whether the organisation appears to be sneaking around the loss.

If a pay, price or product decision needs a spreadsheet to prove that nobody should feel worse off, expect trouble. The maths may be correct. The party hat is still insulting.