Cost of Labor, Not Living, Driving Wage Increases
Workspan Daily
April 01, 2022
Key Takeaways

  • Understanding the landscape. Most employers pay for cost of labor, not cost of living and rising wages are one of the key causes of inflation, not the other way around. 
  • The pandemic’s role. Salaries had arguably not kept pace with economic growth for most of the 2000s. The pandemic triggered mass employee movement and a further tightening of the labor market that has led to significant increases in pay in a short amount of time. 
  • A human capital trend. Human capital’s significance in an organization’s success is more recognizable than ever, and employers who fail to embrace this shift in power by rewarding their talent will fall behind and performance will suffer. 

On Thursday, Federal Reserve Chairman Jerome Powell revealed that inflation reached a new 40-year peak in February, buoyed by supply problems and strong consumer demand in the United States. 

Powell’s revelation that the personal-consumption-expenditure (PCE) price index climbed 6.4% in February from a year ago further stokes ongoing speculation around the economy and what it means for employee wages, which have mostly grown alongside inflation. 

This year’s economic buzzword, however, is not what is driving pay increases, compensation experts say. As more mainstream media conflate the two issues — inflation and pay increases — there’s a misperception among employees that their pay should reflect this rise in cost of living. This is being met by a common trope from employers: 

“We pay for cost of labor, not cost of living.” 

Bill Dixon, a consultant for compensation advisory firm Pearl Meyer, noted that cost of living has not been an element of most employers’ salary planning and budgeting for a “very long time.” 

“Companies that are located in high-cost areas tend to have an adjusted pay structure that allows them to compete in those environments,” Dixon said. “But employers pay the job rates that they need to pay to attract and retain talent.” 

This isn’t to suggest that the two aren’t related, Dixon noted. However, they’re inversely related. Rising pay is one of the primary causes of inflation. If the cost of labor is now increased, mainly as a result of employee movement and a talent shortage, then price points for a product will naturally increase so cost margins remain the same. This, combined with supply chain issues and shortages of raw materials have combined to create the current state of inflation. 

So, how did we get here? 

Dixon said an argument could be made that for most of the 2000s, salaries have not kept pace with economic growth in the U.S. 

“For the longest time, the average salary increase budget was right around 3%,” Dixon said. “Overall, that was unrelated to supply and demand issues and also what was percolating in the broad American workforce. It was really its own indicator and it stayed very stable.” 

This has come to a head the past two years. At the onset of the pandemic, many employers quickly shed employees, which led to record highs in unemployment in April and May of 2020. As the economy began to recover and organizations brought back their workforces, many of whom were now working from home. This has led to unprecedented employee movement, which has been termed “The Great Resignation.”  

One of the key variables in attracting and retaining workers in this new employee-driven environment has been salary increases. 

WorldatWork’s “Salary Budget Quick Poll” conducted in December 2021 through the beginning of January 2022, which had more than 200 compensation professional respondents, reported a projected 2022 average salary budget increase of 4% average and 5% median. Those figures were found to still be about 1 percentage point shy of increases (5% average and 6% median) they say is necessary to maintain/attract needed talent. A “Salary Budget Follow-Up” pulse poll in February focused on merit increases indicated an average actual 2022 merit increase of 3.7% and 3.5% median, which was significantly above predictions from six months prior. 

Judy Canavan, managing director and compensation surveys leader at BDO’s global employer services practice, said the consumer price index (CPI)/inflation is one of a few macro reasons for salary increase budgets being revised upward, along with the talent shortage and ample employee movement. 

“The factors that impact salary increase budget decisions vary based on the industry, location and the nature of the roles that the companies employ,” Canavan said. 

But ultimately, Dixon emphasized, the drastic adjustments to salary increase budgets are the cause of an extremely tight labor market, which is causing organizations to pull out all the stops financially to retain and attract talent. 

“Human capital is essential for companies to execute their strategies,” he said. “If they have shortages or an underqualified workforce, it creates risk for them, so what’s really driving this is more of the demand side.” 

The Human Capital Trend

One of the trends that has emerged during the past couple years is the emphasis that is being put on role that human capital plays in an organization’s success. The U.S. Securities and Exchange Commission (SEC) now requires public companies to include pertinent human capital data within their annual 10-K financial reports. 

This comes at a time when employees are increasingly in demand and well aware of the fact they are in demand, which has factored greatly into the 4.25 million workers per month who have left their jobs. Organizations that are not prepared to embrace this shift in power will fall behind, Dixon said.

“What’s also going on is employees for the first time probably since Y2K have more bargaining power versus the employer,” he said. “You see increases in unionization, that’s an indicator. You’ll continue to see more turnover at poor employers who don’t demonstrate the value for human capital. They will have the toughest time attracting talent and instead of reforming themselves, they will probably just pay higher.” 

Underscoring this transitional period is the increased interest both investors and consumers have in a company’s human capital strategy, which has led to an increase in transparency that Dixon said will continue to fuel above normal pay increases. 

“There is a broader trend going on here,” Dixon said, “which is investors want to know [a company’s human capital metrics and philosophy] and the public want to know and employees want to know as well.”

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