Magazine article Economic Trends

Employee Compensation Costs during the Recovery

Magazine article Economic Trends

Employee Compensation Costs during the Recovery

Article excerpt

01.10.14

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.

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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, borh 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. …

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