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Labor Costs

Growth in compensation costs is monitored by economists as an indicator of future inflationary pressures (compensation costs include employers' costs for wages, salaries, and employee benefits). As measured by the employment cost index (ECI), cost growth has leveled off and begun to slowly recede during the second and third quarters of 2008. In these two quarters, the four-quarter percentage change in the index dipped below 3 percent for the first time since the second quarter of 2006. This moderation comes after solid gains in index growth throughout 2006 and early 2007. Wages and salaries account for roughly 70 percent of total worker compensation, and this component has steadily declined since the second quarter of 2007, suggesting it is largely responsible for the decline in the overall ECI.

Employment Cost and Inflation

Of course, workers might be compensated less simply because they are producing less, but this does not appear to have been the case recently. While unit labor costs (a productivity-adjusted measure of employment costs) started to lose momentum in the first quarter of 2007, changes in this measure have been negatively correlated with changes in output per hour in the nonfarm business sector. This pattern in the two measures has been especially visible since 2000, and the relatively slower growth in unit labor costs coincided with relatively larger gains in output per hour in the nonfarm business sector.

Productivity and Unit Costs

In 2007, almost 72 percent of the total compensation cost for private service workers consisted of wages and salaries. (For workers in goods-producing industries, the figure was 67 percent.) The next-largest components were legally required benefits (8.2 percent), insurance benefits (7.2 percent), and paid leave (6.9 percent).

Distribution of Total Compensation 2007

Even though benefits account for just 30 percent of total compensation, swings in benefits growth have often been large enough to noticeably influence growth in total compensation, particularly when growth in wages and salaries was nearly stagnant. For example, between the fourth quarter of 2002 and the second quarter of 2004, wages and salaries moved from 2.6 percent to just 2.8 percent (in terms of four-quarter percent change), but total compensation growth climbed from 3.1 percent to 3.9 percent because benefits growth shot up from 4.3 percent to 7.2 percent. A similar interaction in the opposite direction was taking place up until the first quarter of 2006: Benefits and total compensation growth both fell, and wages and salaries growth sat tight. The last couple of years, though, have seen a convergence of growth rates, leaving them much more in line with core CPI growth.

Components of Employment: Compensation and Inflation

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