Friday’s report that the Employment Cost Index had increased at the fastest pace in decades confirmed that the Great Resignation is bolstering the bargaining power of workers.
The wage component of the index has now accelerated from a 2.5% rate of increase in the third quarter of 2020 to 4.5% in the fourth quarter last year.
The wage component of the index has now accelerated from a 2.5% rate of increase in the third quarter of 2020 to 4.2% a year later and, most recently, to 4.5% in the fourth quarter of last year on an annualized basis.
For policymakers, the steady increase is a giant red flag as they contend with risks of a wage price spiral that could help make inflation more persistent.
The rising wages came across industries, with the index’s gauge for wholesale trade increasing 6.3%, retail trade advancing 10.9%, and leisure and hospitality increasing 5.6% on an annualized basis.
Private industry workers had a 5% year-over-year gain while workers in service occupations experienced an 8.1% increase. Because increases in the Employment Cost Index have been offset by inflation, nominal wages will remain in catch-up mode compared to rising prices.
And there are signs that the increases are being felt throughout the economy. The Atlanta Fed’s survey of business inflation expectations found that 38% of firms expect labor costs to be a factor in setting prices.
Still, the overall Employment Cost Index, which also measures employee benefits, eased from a 1.3% pace in the third quarter of last year to 1% in the fourth quarter, providing some relief for policymakers on the inflation front.
Wages and available workers
The rise in wages was not to be unexpected, considering the relationship between the demand for labor and the compensation for labor. But to the extent that wage increases will spill over into the cost of living for consumers, this acceleration is likely to factor into the evolution of Federal Reserve policy.
The relationship between the supply of labor and compensation begins with the size of the available pool of labor. You would expect that as the number of available workers falls, then the cost of hiring the next person would increase.
We can measure the pool of available labor by looking at the employment-to-population ratio for prime-age workers, who are 25 to 54 years old. The higher the ratio, the fewer the number of people available to be hired.
At the depth of the pandemic in 2020, only 70% of prime-age workers were employed, leaving a pool of available workers of 30%. As the vaccines increased and the economy came back to life, that ratio increased to 79% as of December last year. That latest ratio implies an available pool of only 21% of the prime-age population left to hire. Though the 70% employment ratio was an outlier, the increase to 79% implies at least a step toward normal labor market conditions.
What’s left for the monetary authorities to discern is if the 4.2% increase in employee compensation is also an outlier or a trend toward higher compensation that complicates their mandate for price stability.
On a longer view, the economy’s transition to service-sector employment had long ago taken its toll on employee compensation. The 7% wage increases of the 1970s became the 3% increases of the 1990s and the sub-2% increases of the 2000s. At the same time, the availability of low-cost imports led to insufficient (1.5%) levels of inflation.
But now, after the shock of the pandemic, prices are rising in response to a shortage of goods and labor. While the upward pressure on the prices of goods is likely to subside when inventories are finally rebuilt, the pressure on wages is indeterminate at this time.
It seems more likely that this year’s jump in starting salaries for low-wage occupations will not be repeated. But we won’t know if wages for higher-wage occupations jumped until the end-of-year data is reported. We also won’t know if businesses will, in the end, be able to absorb wage increases or if they will pass them through to consumers.
And although employee benefits (the second part of the Employment Cost Index) have been in general decline, we could see increases given the shortage of workers. There is a need for affordable child care and health care, and employers may resort to offering those services to compete for workers who have not yet returned to the labor force.
