Many employees are wondering what has happened to their pay increases. The economy has improved, stock markets are at an all-time high, and the unemployment rate is down, but raises are well below their pre-recession levels. Prior to the recession, employers generally budgeted wage increases of 4% per year. Employers in 2014 increased wages by 3% and forecast a 3.1% increase for 2015. That's a decrease of 25%.
Let's look at some additional numbers:
- The US April unemployment rate was 5.4%, and Florida's was 5.6%. Both values are at a record low since the recession and are at or near the Federal Reserve's unemployment target range of 5.2% - 5.5%, which is considered full employment.
- National wage increases, measured by the employment cost index (ECI), have been anemic since the recession in 2008. For the period of 2009 - 2014, wage growth has averaged 2.3% annually. US wages in the last year increased 2.6%, while Florida's average weekly wage increased 2.1% (3rd quarter 2013 - 2014).
Economics has taught us that as supply of workers decreases, wages should go up. So what is wrong with this fundamental concept of classic economics?
Not Everyone Is In the Labor Market
The PEW Research Center reports that 37% of the civilian population older than 16 is not in the labor force, near an all-time high. This means that they aren't working now and have not looked for work recently enough to be counted as unemployed.
The chart on the right shows that this statistic isn't just baby boomers retiring, although they certainly contribute to this number. Instead, it shows that a higher percentage of people in the younger age groups have opted out of the workforce. The study's most telling finding is a 10% increase of 16- to 24-year-olds disengaged from the workforce.
This slack in the labor force can be explained in a few ways. During the recession, layoffs were common as companies cut costs due to falling profits. Laid-off employees had to endure poor prospects for reemployment and became discouraged. Many opted out and became long-term unemployed or took positions at lower wage levels. Younger Americans have only experienced recessionary conditions in their work life, causing some to remain in school or not seek employment. Additionally, not captured in this statistic are 7.2 million people with part-time jobs who say they cannot find work, according to Eric Rosengren, president of the Federal Reserve Bank of Boston.
The high number of people not pursuing work and those in part-time positions seeking full-time opportunities suggests that the relatively low unemployment rate does not paint an accurate picture. As the economy improves, these groups should begin to reengage in the workforce. This will increase the available supply of labor, which will continue to constrain wage pressures.
Differences in Industries and Jobs
World at Work, a compensation professional association, gathers data on pay practices across companies. The association reported construction, mining (including oil and gas), and forestry as the industries that increased wages the most in 2014. Entertainment and recreation, educational services, health care and social assistance reported the lowest changes to employee wages in 2014. The raises in the higher-paying industries were 45% greater than those in the lower-paying industries.
There is a significant difference in wage pressure by job levels. Employees in relatively lower-paying positions have seen their ability to command higher wages erode due to a number of factors, including increased automation and a decrease in union representation. Higher-paid employees have continued to stay relevant in the labor market, providing specialized knowledge and skills to employers, and continue to enjoy higher wage increases. The Economic Policy Institute's The State of Working America study notes that real wages (adjusted for inflation) exhibited the strongest growth in those jobs with pay in the top half of wage earners for the years 1979 - 2011. Real wages for the lowest 10% of the workforce actual decreased by 4.3% over the time period. This is not surprising when you consider that the current Federal minimum wage is 23% below its peak inflation-adjusted value in 1968.
Increasing the Minimum Wage and the Walmart Effect
Twenty states raised their minimum wage effective in 2015. Major employers such as Walmart, McDonalds, Target and Facebook announced wage increases for their lowest-paid employees in recent months. However, this will not cause an increase in wages throughout the workforce. Yes, the lowest-paid workers will receive a one-time gain in compensation, and companies who employ workers at or near the minimum wage will need to react to Walmart by increasing pay. Companies with entry-level jobs in retail and food service will be affected. This will have little to no effect on higher paying jobs that are compensated above the new minimum wage levels.
It's interesting to note that Walmart and McDonalds also announced planned improvements in career opportunities and paid time off, respectively. These changes will likely go farther to increase employee satisfaction than the proposed wage changes.
PAY STRATEGIES FOR COMPANIES GOING FORWARD
Labor markets are going through structural changes that call for different approaches from pre-recession strategies. Compensation programs should align with the changing conditions. Here are a few strategies to consider:
- Overall wage pressure should remain muted as the slack in the labor force further engages with growing job prospects. General wage increases will not return to pre-recession levels for quite a few years. However, companies should be conscious of their specific industry wage trends.
- Employers should consider potential wage changes differently for different segments of their workforce. The historical data suggests that higher-paid jobs have seen greater pay increases than lower-paid jobs. Whether this is a socially appropriate strategy is a separate question.
- Although still constrained, wage increases have accelerated since the recession. Companies should ensure their salary management systems are externally competitive. No organization wants to lose its high performers to competitors because its pay isn't competitive with the market.
- This is a great time for companies to consider a variable or incentive pay plan to complement their base pay programs. Merit increases will likely average 3% for the foreseeable future. It is difficult to reward top performers in a constrained fixed pay environment. Utilizing incentive pay has the advantages of not increasing fixed costs and tying potential rewards to desirable business outcomes.
- Although competitive wages are certainly an important reason employees remain with organizations, they are not the only reason. Companies should consider enhancing their efforts in career growth and performance management, building an engaging company culture, and providing work / life balance. These factors are most significant in retaining employees.
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