It’s a question you’re likely already being asked, even though you’re probably still recovering from your most recent annual pay cycle. And, if you’re like me, you’ve been looking at different economic indicators to get a handle on how the current state of the economy will likely influence salary budgets – up, down or stable.
Just to refresh, 2022 saw salary budgets in most parts of the world increase significantly for the first time in more than a decade. In the U.S., for example, salary budgets climbed more than 1% to 4.2% for merit increases alone, and 4.6% in total. These increases came after 10-plus years of salary increases hovering around 3% with little to no change.
As I wrote in January, going beyond the latest headlines to understand the external economic factors can help you make effective pay decisions. Unfortunately, this year seems more difficult than most in determining which way salary budgets will change (or not) because those external economic factors are highly dynamic, can be industry specific and often are too short-term focused.
Our Global Salary Budget Planning Survey, published in July and December reports on salary increase budgets and important economic indicators, including inflation and employment rates for 133 countries.
While the December survey reflects what organizations will likely pay for salary increases, it also is a view of salary-increase decisions that are fairly solidified by that point in the calendar-year salary cycle. The July survey, on the other hand, is as close to a crystal ball view of salary predictions that you will be able to get.
It’s impossible to read everything on the topic of the U.S. economy, let alone completely keep up with economic conditions in other countries. The No. 1 thing I look at is the unemployment rate and its close relative, job creation.
So, here’s the scoop on both for the U.S.: 2021 and 2022 were the two best hiring years since the U.S. government began measuring this in 1940. The number of new jobs created was expected to slow significantly in 2023 given the Federal Reserve Banks’ aggressive campaign to raise interest rates. But in January, more than 500,000 new jobs were created compared to 239,000 in December, and unemployment dipped to 3.4% – its lowest rate since 1969.
That said, February and March did see few jobs created; 311,000 and 236,000 respectively. While these numbers have declined, the Fed raised interest rates again by 25 basis points in March, a further indication that they consider the job market to still be pretty hot. In this, the Fed would be correct given that anything over 200,000 new jobs created prior to 2021 would have been considered a big deal for the U.S. economy and job growth.
Many economists and prognosticators are predicting the unemployment rate will rise to 4.5% by the end of 2023, but I’m skeptical – especially in high-attrition jobs like frontline hourly roles, the likes of which are still making headlines.
I also keep hearing that the "great resignation" is over, but according to the Job Openings and Labor Turnover Survey (JOLTS) conducted by the U.S. Bureau of Labor Statistics, 3.9 million U.S. employees quit their jobs in March, which was only slightly below the 4 million that quit in February. While that’s down from the 4.5 million Americans who quit their jobs a year earlier in March of 2022, I don’t think we can’t quite call the great resignation over.
The bottom line: If unemployment stays low, salary budgets will stay where they are for the coming annual cycle.
Annual salary-increase budgets do follow economic indicators and, as mentioned, the supply and demand of labor as represented by the unemployment rate is the leading indicator. Your leaders may be reading the headlines and thinking that, because the U.S. economy is slowing, salary increase budgets should start trending downward again. But it doesn’t quite work that way. Here’s why:
Salary budget changes typically lag economic changes by 12 to 18 months, except in times of drastic economic downturn, such as the Great Recession of 2008-2009. Back then, the unemployment rate rose nearly every month as a significant number of organizations laid off thousands of employees weekly (starting in early 2008) and salary increase budget projections dropped as unemployment rose. Given our current unemployment rate, even with what most experts are predicting as a gradual increase by year end, it’s unlikely that salary increase budgets will go down in the next year.
Unlike past economic slowdowns, the dynamics of the current U.S. economy are confusing to say the least. U.S. GDP growth certainly has slowed but did still increase by 1.1% in Q1 2023. However, when you dig beneath the surface of the numbers, you find – once again – there are industry winners and losers, just as we saw in 2020 when the pandemic struck. The only difference now is that the losers are winners and vice versa. So, airlines, hotels and restaurants are growing while e-commerce is shrinking. With such diverse outcomes, salary increase budgets often reflect status quo, just as they did in 2021 when they didn’t increase much past the 3% we’d had for a decade. I predict the same will happen this year: Salary budgets won’t budge much from where they were last year, meaning, in general, a low probability of a decrease in salary budgets, though that could vary by industry.
While layoffs are still happening and being painfully felt in certain industries (e.g., high tech), they are still not widespread like they were during the Great Recession. Therefore, they are not impacting the overall health of the job market. Most notably, many (if not all) of the organizations conducting layoffs are continuing to hire – a practice that strongly suggests current conditions are much more about a correction than a true recession.
Inflation is expected to continue trending downward, while I am predicting salary budgets will stay around the same as last year. Hmmm…isn’t that interesting? So, at year end, when employees ask for increases that are aligned with inflation, you can tell them that would represent a lower salary increase (on average) than you were planning.
I probably don’t have to remind most of you that inflation is based on a different economic indicator (a market basket of goods, the largest of which are housing, food and energy) than the basis for salary increases (the supply and demand for labor in a given market). But if any of your leaders suggest that salary increases should be trending downward because inflation is also now trending down, remind them that you used this explanation to set salary budgets well below inflation in the past two years and they can’t have it both ways.
Inflation can be really confusing for global organizations, as it is driven by different things in different countries. Therefore, it also can have a diverse impact on salary budgets for different countries.
For example, energy price shock is more of an inflation driver in the U.K. and the Eurozone than it is in the U.S, while continued price increases and tight labor markets are driving U.S. inflation but not as much in the U.K. and Europe. Weak and fragile currency and government instability are factors in other countries such as Turkey and Argentina, where hyperinflation is a reality not seen in other countries.
Understanding how your salary increase budgets may fluctuate not only this year but also in the future requires the right data as well as an understanding of the key economic indicators that influence how we spend our compensation dollars and deliver defensible, competitive pay programs.
