In April 2022, I covered why – despite severe talent shortages and the ongoing impact of the great resignation – corporate salary increase budgets trailed inflation and why salary increases move differently from inflation.
A year later, salary increases continue to move differently than inflation under changing economic conditions. With inflation now dropping in the U.S., it is possible that salary budgets could return to exceeding inflation in 2023 (which was the case in the low-inflation years from 2007 to 2020) or remain short of it (which was the case in high-inflation years such as 1979, 1980, 2021 and 2022).
According to WTW’s Salary Budget Planning Report, a survey of U.S. companies conducted in early 2022, employers were budgeting an overall average salary increase of 3.4%, which was less than half the then-current inflation rate of 7.9%. At year-end, another WTW survey reported the average U.S. salary increase grew to 4.2%, but still a third below the 2022 U.S. inflation rate of 6.4%.
As U.S. inflation trends downward in 2023, the projected average total salary increase has risen to 4.6%. Given these trends, it is unknown whether salary increases will outpace inflation, be similar or be lower this year.
With thanks to WTW’s Lori Wisper, who provided additional analysis in her recent article, Recession, layoffs, inflation, worker shortages: What it all means for 2023 pay increases, several factors continue to account for the difference:
01
While inflation and salary increases generally move in the same direction and impact each other, they are driven by different inputs. Inflation is defined by changes in the cost of a market basket of goods (such as housing, groceries and fuel). Pay, on the other hand, is driven by changes to supply and demand for labor, which can be caused by demographic trends, labor participation rates, unemployment levels, 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. This difference tends to make employees feel advantaged in terms of real spending during low-inflation years and feel disadvantaged during high-inflation years. Independent of inflation, pay increases generally are expected to remain high as long as unemployment remains low.
02
Employee benefit costs went up materially in aggregate in 2020, 2021 and 2022. These costs (such as healthcare and retirement plans) are not captured in salary increase budgets but do reflect actual increases in employer spending. They are captured in what economists call “wages” – and do factor into inflation – but often are not discussed when referring to salary increases. In most years, employer spending on employee programs outpaces inflation, with pay representing only one component.
03
A basic principle of labor economics is that pay increases are “sticky.” Effective leaders know pay levels are difficult to reduce if markets deteriorate and are slow to raise them before determining long-term implications. For example, when the U.S. unemployment rate spiked at the outset of the COVID-19 pandemic, employers generally did not reduce individual salaries, nor are they reducing them now that inflation has declined.
When labor markets became tight in 2021 and early 2022, many employers increased salaries for the highest demand jobs and individuals, while seeking to keep overall pay levels stable. Given the drops in inflation during the second half of 2022 and in 2023, as well as the widespread layoffs in industries that aggressively hired and increased salaries, many leaders are relieved they acted with caution.
04
Because pay is sticky and inflation accounts for past results, there tends to be a lag before their interaction is understood. For example, much of the rise in individual pay levels during the pandemic was 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 changed jobs either through promotions or by switching employers during the great resignation.
However, this pattern was not fully understood until much later. Additionally, certain measures of inflation (such as housing) have substantial lags, resulting in overstated inflation during certain periods.
Effective leaders manage through multiple volatile business cycles by remaining competitive while keeping an eye on increasing fixed costs that could leave them no choice but to lay off valued employees during downturns. They are careful about who they offer salary increases to, offer more flexible bonus, stock and employee benefit plans, and they work to create strong culture and employee experiences, developing great places to work instead of driving up fixed-pay costs.
A version of this article originally appeared on Forbes on May 17, 2023.
