A Closer Look at the Employment Cost Index

By Garner, Alan | Business Economics, July 1999 | Go to article overview

A Closer Look at the Employment Cost Index


Garner, Alan, Business Economics


Many economic analysts believe the employment cost index is the best available measure of U.S. labor costs. For example, Abate referred to the ECI as "the best measure of compensation costs," and Griggs and Santow, Inc., described the ECI as "the best measure of wage behavior and benefits being paid, and of the pace at which such employment costs are rising." In many respects, these sentiments are probably correct, but other potentially useful measures of labor costs exist, including the average hourly earnings index and unit labor costs.

An Introduction to the ECI

The ECI is a quarterly measure of labor compensation per hour worked, including all wages, salaries, and benefit costs paid by employers. Wages and salaries are based on straight-time average hourly earnings, whether or not the employee is normally paid by the hour. Wages and salaries have historically accounted for a little over 70 percent of total employment costs. Nonwage benefits include paid leave, other supplemental payments, and employer contributions for insurance, retirement and savings plans, and legally required benefits.

The inflation rate of the private-sector ECI has roughly paralleled the overall inflation rate, measured by the GDP price index, since 1980.(1) The GDP price index is a broader measure of the general price level than the CPI, reflecting purchases by businesses and governmental units as well as consumers.

Growth rates of the two major ECI components have sometimes differed substantially in the 1980s and 1990s. The growth rate of benefit costs exceeded the growth rate of wages and salaries during most of this period. For example, benefit costs grew at an average annual rate of 5.6 percent from the second quarter of 1981 to the fourth quarter of 1994, well above the average growth rate for wages and salaries of 4.0 percent over the same period. However, benefit cost inflation has slowed sharply in the past few years, while wage and salary gains have increased moderately. As a result, benefit costs have risen at only 2.2 percent annually from the fourth quarter of 1994 to the first quarter of 1999, well below the 3.3 percent rate for wages and salaries.

As with all economic statistics, the ECI is subject to measurement problems. For example, the ECI does not capture certain forms of labor compensation, such as stock options and signing bonuses. Moreover, the Bureau of Labor Statistics collects information for only a small percentage of all relevant employees because of the costs involved. As a result, the ECI will have "sampling errors" when wages and benefits for this small group do not behave exactly the same as wages and benefits for all relevant employees. In addition, the ECI is computed for a fixed basket of industries and occupations, similar to the fixed market basket of goods and services in the consumer price index (CPI). As a result, the ECI is potentially subject to statistical biases caused by the fixed industry-occupation weights. Economists have criticized the CPI for this and other biases, suggesting that the index has overstated the inflation rate. However, research conducted at the BLS found the use of fixed industry-occupation weights does not cause large statistical biases in the ECI.(2)

Comparison with Other Labor Cost Measures

The ECI differs in various ways from two other measures of labor costs: the average hourly earnings index and unit labor costs. The average hourly earnings index reflects changes in basic hourly and incentive wage rates as well as such variable factors as premium pay for overtime and late-shift work. Being a monthly series, the average hourly earnings index is more timely than the ECI. But the ECI is a more complete measure of labor costs, because it includes many important elements of labor compensation, such as nonproduction bonuses, health insurance, and payroll taxes paid by employers, that are not in average hourly earnings.

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