Employee Compensation Costs during the Recovery
The Federal Reserve’s two mandates—to keep inflation under control and to promote employment growth—overlap when it comes to employee compensation. Inflation typically leads to increases in nominal compensation, and firms increase prices in response, creating a feedback loop that pushes inflation higher. Compensation also rises when labor markets are strong and firms have to compete for workers, and it falls when labor markets are weak. So when compensation costs are rising, it can indicate greater risk of inflation and strengthening labor markets. When they’re falling, it can indicate the reverse. Which has it been lately?
The Bureau of Labor Statistics’ quarterly Employer Costs for Employee Compensation provides detail on the components of average hourly compensation. As shown in the chart below, in the third quarter of 2013 wages and salaries were 69.1 percent of compensation costs. The other major parts of compensation are health insurance (8.5 percent), legally required benefits (which includes unemployment insurance and the employer’s share of payroll taxes) (7.8 percent), and retirement and savings benefits (4.8 percent). Though we most often use salary earnings as a proxy for compensation, earnings and compensation can have different trends since earnings make up only about two-thirds of compensation. For example, from the first quarter of 2004 to the third quarter of 2007, average real hourly wages declined 0.8 percent, while average real hourly total compensation rose 0.9 percent.
All components of compensation costs dramatically shifted up during the most recent recession. This shift is most likely due to the fact that these measures are average hourly costs for employed workers. Less-skilled workers are more likely to lose their job in a recession than high-skilled workers, so the skill and compensation levels of the workers who remain employed during a recession are higher. While real average hourly wages and salaries fell 3 percent from the first quarter of 2004 to the third quarter of 2013, both health insurance and retirement and savings markedly increased (17 percent and 20 percent, respectively). As a result, total average hourly compensation was effectively the same in the two periods.
We divide the data into pre-recession (2004:Q1 to 2007:Q3) and recovery (2009:Q2 to 2013:Q3) subsets and omit the recession due to the sudden change in who is employed. When we do this, we see that while total compensation rose 0.2 percent per year before the recession, it has declined 0.5 percent per year since the recovery began. Meanwhile, wage and salary compensation fell 0.2 percent per year before the recession and 0.8 percent per year since the recovery began. Legally required benefits and wages and salaries follow similar trends during the two periods, which is unsurprising since most components of legally required benefits are based on wages and salaries. Health insurance and retirement and savings benefits grew in both periods, but the rate of growth was much higher before the recession (4.4 times as high for health insurance and 2.3 times for retirement and savings). Other compensation grew about 1 percent per year before the recession, and it has declined about 1 percent per year since the recovery began.
What explains the decline in average compensation during the recovery? As the economy recovers, less-skilled workers find work again and average hourly compensation falls. Also, the higher-than-normal unemployment rate means employers do not need to increase compensation to fill openings. The decline in average compensation may also reflect the shift to more part-time employment during the recession. Part-time workers are less likely to receive health insurance and retirement benefits than are full-time workers, so part-time workers have lower compensation costs. The share of workers who are part-time fell more quickly in the pre-recession period than it has during the recovery, which would suggest slower benefit growth in the recovery.
Employers’ average health insurance costs are growing more slowly both because a smaller fraction of workers have employer-provided health insurance and because health care costs are rising more slowly than they did in the past. Based on the microdata from the American Community Survey, the fraction of workers who have employer-provided health insurance declined 4.5 percentage points from 2008 to 2011, with part-time workers experiencing the largest decline. We also know that health care costs, which increased faster than the general rate of inflation for many years, have been growing more slowly. The Bureau of Economic Analysis’s Personal Consumption Expenditure Health Care Price Index shows that during the recovery, health care prices grew about half as fast as before the recession.
The decline in compensation costs during the recovery suggests that the two components of the Federal Reserve’s dual mandate are not in conflict at this time. Inflation risk is low, and the labor market is soft enough that firms can hire without having to increase compensation.