Is Wage Inflation Imminent

September 1, 1998
Does the current tight labor market feel like a pressure-cooker to you? It should. From placards in business windows on Main Street to signing bonuses for pubescent employees, wage-earners everywhere know that today's corporate mantra is "Employees wanted-part-time, full-time, anytime." With unemployment at a stunning 4.3 percent at press time, there are signs everywhere that show the market is about to blow the lid off our wage complacency.

Consider the ingredients in the pressure-cooker: unemployment is at a 28-year low; there's been more than 3 percent wage inflation (according to the Employment Cost Index of the Bureau of Labor Statistics, March 1998); and while corporate profits rose 20 percent each year from 1992 to 1995, two million workers lost their jobs and those who were working got skimpy raises, if they got them at all. Doesn't common sense tell you that serious wage inflation must follow?

Many economists note that you can already see the steam rise. Salaries and wages for executive, administrative and managerial occupations rose 4.9 percent over last year, with the service sector outpacing manufacturing. In the broad areas of professional services and information technology, the markets are fiercely competitive, and have been for the last several years, which drives wages up.

Meanwhile, recent college grads are commanding higher starting salaries than their predecessors. Packages offered to MBAs have skyrocketed 10 percent or more, and even psychology majors are being offered 8.9 percent more than they were a year ago. Mitchell Held, an economist with New York City-based Salomon Smith Barney, suggests that in some sectors, these increases are starting to mirror what we saw in the late 1980s.

Despite these indicators of wage inflation, the government still reports that total compensation, including benefits, is increasing 3.3 percent, which is smack in the middle of the range we've seen over the last seven years. "It's interesting that with such low unemployment, we haven't seen it driving up wages significantly," says David Smith, assistant professor of economics at the Glaziadio School of Business at Malibu, California-based Pepperdine University.

So what's going on? Can we breathe a collective sigh of relief and leave the kitchen, assuming the pressure-cooker can be unattended?

No. Wage inflation seems inevitable, though experts argue about the rate. The real news, however, is that we have to consider wage inflation in ways we haven't looked at it before.

What's keeping the market at these levels?
To begin with, the economy is working harder than usual to keep wage inflation in check. Inflation is running 2 to 3 percent, which bolsters the status quo. The real gross domestic product (GDP) plays a role, too. Economists believe growth that is greater than 2.5 percent is healthy, although growth that is greater than 3.5 percent raises fears that an overheating economy will result in inflation. The GDP increased 3.7 percent in 1997, but is forecasted to grow only 3 percent this year-this more moderate growth projection has eased fears of inflation.

There are other competitive forces at work, too. "The strike at General Motors eases the labor market because of direct lay-offs, as well as the related industries that are affected," says Smith. "The Asian [economic] crisis also has a cooling effect on jobs here."

And despite the outward cockiness of many employees, they may privately admit to some lingering concerns about job security. Given the incentive options and restricted stock that companies have granted to many employees, it has increasingly become expensive for many people to take a job down the street for just a few dollars more.

The unusual interplay of these elements in the economy is working to keep wages stable, but it is being offset by other elements that are driving wages up. First, history is catching up with us. For the past seven years, employee wages represented the lowest share of national income since 1968; profits during this period represented the highest share since 1968. Today's workforce is eager to make up for lost time.

In many ways, it's already happening. Entrants to the job market are earning more than their predecessors, which has turned up the heat beneath the pressure-cooker-and it's only a matter of time before that group expects wages and those ahead of them demand parity. In addition, we've become more creative in how we pay people. Signing bonuses, stock options and giveaways from pizza to vacations are now commonplace, but they aren't figured into government measures of salary-meaning wage inflation is undoubtedly higher than numbers indicate.

Look at wages in context.
Should you be panicking and planning an off-site meeting to rework your compensation strategy? Should you be making plans for rampant wage inflation and start cutting costs elsewhere to make up for it? Yes and no.

More has changed in recent years than the ways we pay people for their services. The entire work contract has changed. Guaranteed job security is out; a focus on careers and job skills is in. Accordingly, employees are looking at much more than just wages when making job choices (see "Job-hunting Professionals Are Looking for Respect," Workforce, June 1998). They're also watching corporate culture, advancement opportunities and other factors. Given that change, it doesn't make sense for employers to isolate the wage issue, either.

Yes, the wages you pay must be competitive, and it's safe to assume that you can't hold the line on wage inflation much longer. But the pressure to recruit and retain talented employees only begins with wages and salaries. Even in such overheated environments as professional services, where a dozen calls a week from search consultants isn't unheard of, you don't want to take an ad hoc, reactive approach. "Especially in tight labor markets, when individuals are already working long hours [and] they're being compensated well, they're going to value other sorts of things-things that aren't often taxed," adds Smith.

"Going to an ad hoc compensation approach just to get people in the door actually works against retaining your broader workforce," says Fran Engoron, global leader for organizational effectiveness and development at New York City-based Pricewaterhouse Coopers. "We want to be at the high end of competitive pay within the marketplace, but we want to be there for all of our people, not just the new ones," she says. The company has an overall philosophy that offers a total work experience, including stimulating work content, an enriched personal development program and extensive training-a work environment that's fun and embodies a sensitivity to work/life balance.

Clearly, golden handshakes and sign-on bonuses will get individuals to join. Equally apparent is the fact that many sectors need a fire to light up some of the wages and keep them fair. Nevertheless, HR's best approach to the question of wages and salaries is to view it within the total structure of the organization.

Workforce, September 1998, Vol. 77, No. 9, pp. 103-104.