Monday, 16 of July of 2018

Economics. Explained.  

Hourly Compensation

May 3, 2018

The Bureau of Labor Statistics indicated that compensation rose 3.3% in the first quarter after having risen 2.4% in the fourth quarter.  This means that over the past year hourly compensation has climbed by 2.5%.

But, as noted in the section on unit labor costs, what really matters to an employer is not how much they pay someone, but how much they pay them adjusted for the change in productivity.  If I pay you 3% more money, but you are 3% more productive, I really do not care.  I am getting 3% more output from you.  That increase in labor costs adjusted for the change in productivity is known as “unit labor costs”.  If I pay you 3.0% more money but you are no more productive, then my unit labor costs have risen 3% and I may need to raise prices to compensate for the additional labor cost.  So watch compensation, but focus even more closely on unit labor costs.

Currently, unit labor costs have 1.1% in the past year.  Given that result, it is no wonder that the exceptionally tight labor market has not yet put any upward pressure on the inflation rate.  Increases in compensation are being largely offset by gains in productivity.  Going forward, the tightness in the labor market should cause compensation to climb by 3.5% in 2018.  But the corporate tax cuts combined with an opportunity to repatriate earnings at a favorable tax rate, and steady progress in relieving the currently onerous regulatory burden, are boosting investment spending.  And since investment spending is the primary determinant of the growth rate of productivity, we expect productivity to grow by 1.5% in 2018.  As a result, unit labor costs in 2018 should rise by 2.0%.  That will put only a slight amount of upward pressure on the inflation rate and seems entirely consistent with the Fed’s 2.0% inflation target.

Growth in hourly compensation is a good thing, but some of that increase can be offset by inflation.  So what we are also  interested in is real hourly compensation.  In the first quarter real compensation declined 0.1% after having fallen 0.9% in the fourth quarter.   The fourth quarter decline consisted of a 3.3% increase in compensation which was more than offset by a 3.4% increase in inflation .  In the past year real compensation has risen 0.2%.  Looking ahead into 2018 we expect compensation to increase 3.5% as the tight labor market pushes wages higher, but that will be partially offset by a 2.4% increase in the inflation rate.  Thus, real compensation this year should increase by 1.1%.

Stephen Slifer


Charleston, SC

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