Why salary increases do not keep pace with inflation

Despite severe talent shortages and the ongoing impact of The Great Resignation, corporate salary increase budgets trail inflation in 2022, surprising many leaders.

For example, in the U.S., the Bureau of Labor Statistics (BLS) recently reported a 7.9% increase in the Consumer Price Index (CPI) before seasonal adjustment over the last 12 months. BLS also reported the U.S. national unemployment rate dropped in March to 3.6%, nearing pre-pandemic levels.

Yet a survey of U.S. companies found employers now are budgeting an overall average salary increase of 3.4% in 2022, which is less than half the current inflation rate (though notably it represents a substantial rise from the average 2021 salary increase of 2.8% - a 21% difference).

With thanks to a recent analysis published by WTW’s Lori Wisper, several factors account for the difference:

1. 01

   Inflation and salary increases are not the same

   While inflation and salary increases generally move in the same direction, they are driven by different inputs. Inflation represents changes in the cost of a market basket of goods (such as groceries and fuel). Wages, on the other hand, are driven by changes to supply/demand for labor which can be caused by demographic trends, labor participation rates, technological advances, and growth in productivity. For example, in 1979 – the year of the highest peacetime inflation on record – U.S. inflation was 13.3% but wage increases were a much lower 8.7%.

   Conversely, U.S. inflation was 1.9% in 2001, but salary increase budgets were much higher - near 4% - in 2001 and 2002. In 2020, inflation was a low 1.4% but salary increase budgets in 2020 and 2021 were higher (between 2.5% and 2.8%). This reality tends to advantage employees in terms of real spending during low-inflation years (such as 2001 or 2020) and work against them during high-inflation years (such as 1979 or 2022).

2. 02

   Wages are sticky

   A basic principle of labor economics is that wage increases are “sticky,” meaning they tend not to go down unless significant structural issues are present. Because wages are difficult to reduce if markets deteriorate, companies are slow to raise wages before determining long-term implications.

   When the U.S. unemployment rate spiked at the outset of the COVID-19 pandemic from 3.5% in February 2020 to 14.8% in April 2020, employers generally did not reduce individual salaries. While layoffs and lower annual bonuses reduced aggregate compensation levels, the salaries of remaining employees did not decrease (in fact, pay increased for many jobs due to demand for essential workers and skills). Similarly, now that unemployment is back to pre-pandemic levels (partially offset by lower labor participation rates), employers are evaluating long-term trends before ratcheting salaries far beyond pre-pandemic levels across the board.

   While many employers opt to increase salaries for the highest demand jobs and individuals, they also seek to keep overall pay levels stable.

3. 03

   Pre-pandemic salary budgets already began to reflect labor market demographic changes

   Even before the pandemic, a demographic “perfect storm” was brewing in developed labor markets, reducing talent availability at both the leadership and entry levels of organizations. For example, in the U.S., despite overall population and labor force growth, the labor force actually shrank from 2010 to 2019 in age groups 16-24, the historical entry-level talent pool, and 45-54, the historical leadership talent pool, demonstrating this problem originated before the pandemic and became further exaggerated by reduced labor participation rates.

4. 04

   Job changes, the rise in starting salaries, and benefits do not appear in annual salary budgets

   Much of the rise in individual pay levels has been due to a combination of increased starting salaries to attract new workers at entry levels (especially in industries such as healthcare, life sciences, technology and distribution) coupled with significant salary increases for individuals who have changed jobs either through promotions or by changing employers during The Great Resignation. In addition, employee benefit costs went up materially in the aggregate in 2020 and 2021. None of these are captured in salary increase budgets but nonetheless reflect real increases in employer spending.

5. 05

   Companies are investing in flexible employee programs and culture to supplement fixed pay

   Leaders who have managed through multiple volatile business cycles (including the Great Recession of 2008 to 2010) keep an eye on increasing fixed costs that could leave them no choice but to lay off valued employees during downturns. These leaders know what it takes to survive with extremely scarce resources and strive to be prepared and agile when faced with unpredicted events; they offer more flexible bonus, stock, and employee benefit plans and work to create strong culture and employee experiences in place of driving up fixed pay costs. These costs also are not captured in salary increase budgets.

Future-seeking leaders understand the difference between consumer inflation and labor market growth. They aim to balance short- and long-term requirements, and work to respond to employees’ needs and wants, as well as create great places to work in an increasingly complex environment.

A version of this article originally appeared on Forbes.com on April 7, 2022.

Author

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John M. Bremen

Managing Director and Chief Innovation & Acceleration Officer

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