Greater wage growth is great news for workers but challenges employers that want to hire and retain talent while controlling labor costs.
The Bureau of Labor Statistics (BLS) reported Jan. 6 that the average hourly wage rose by 10 cents in December 2016 from the previous month to $26.00 and rose by 2.9 percent over the year, representing the largest annual increase since 2009.
"Wages are rising as labor market slack has declined and we have reached the vicinity of what economists call 'full employment'—the maximum sustainable level of aggregate employment that [the labor market] can maintain without setting off inflation," said Josh Wright, chief economist for recruitment software company iCIMS, based in Matawan, N.J.
The slow growth in workers' wages over the past several years has been one of the most prominent weaknesses in the country's economic recovery. "It has been the No. 1 source of puzzlement for many economists," said John Challenger, chief executive officer of Challenger, Gray & Christmas, a Chicago-based outplacement consultancy. "Low unemployment conditions generally lead to wage inflation. Everyone figured that growth has to begin showing and it's finally showing up."
But average wage growth is still lower than normal, which can partly be explained by the compositional effects on the average wage rate, said Gad Levanon, chief economist, North America, for The Conference Board, a New York City-based business membership and research association.
The average wage rate as measured by the BLS includes retired people, many of whom have higher salaries, and younger people just entering the labor pool, which pushes the average wage down.
He pointed to the Atlanta Fed's Wage Growth Tracker, which measures the nominal wage growth of individuals over 12 months' time. "In that measure you see a significant acceleration … more of a true reflection of wage growth because it lacks the bias from compositional effects holding it down." The Atlanta Fed measured the median wage growth in the last quarter of 2016 to be 3.5 percent.
Employers Left with No Choice
Wages are rising primarily due to the fact that the labor market has tightened as more people have found jobs, said Joseph Coombs, a former senior analyst for workforce trends at the Society for Human Resource Management. "In a competitive market for top talent, employers need to improve compensation packages in order to retain and recruit workers."
Challenger said that labor market conditions have built up to where employers ultimately were left with no choice but to raise wages to hold onto skilled workers.
"We finally started to see a shift from employers the last couple of years who, coming off the Great Recession, had been hesitant to increase wages and frankly were trying to get a better bang for their buck," said Amy Glaser, senior vice president of Adecco Staffing USA. She noted that during the peak holiday season in the fourth quarter of 2016, Adecco saw salary increases from e-commerce and logistics customers of "anywhere from 25-50 percent" and a "15-20 percent uptick on prior wages going into 2017."
Nineteen states and 21 local jurisdictions raised their minimum wages at the start of 2017, according to the National Employment Law Project, a workers' rights advocacy group based in New York City.
Experts agreed that minimum-wage increases around the country have helped at the bottom end of wage distribution but that the impact on the average wage growth has been minimal.
Challenger added that minimum-wage pressure was exerted at both the exempt and nonexempt levels, explaining that even though the Department of Labor's overtime regulation raising the salary threshold for exemption was not enacted, it was grounded so late in the process that many companies had already increased workers' wages in preparation for it.
Industries such as health care and IT have experienced the fastest growth, creating more demand for labor, and thus should see the strongest wage inflation, Challenger said. But he cautioned that the increased demand in the health care sector could be curtailed by the dismantling of the Affordable Care Act. On the other hand, "we could see more demand in the skilled trades in 2017 thanks to [President Donald] Trump's infrastructure program and deregulation of environmental regulations."
According to ADP's Workforce Vitality Report for 2016, the strongest wage growth has been seen in the leisure and hospitality, construction, finance, and IT sectors. Wages grew the most among women and younger workers and those employed in large companies.
Even with average hourly earnings rising significantly, from a 1.7 percent increase in 2014 to a 2.9 percent increase by the end of 2016, critics argue that wages are still below par. With an inflation goal of 2 percent and productivity growth of about 1.5 percent, average wages should be rising annually by at least 3.5 percent, experts believe.
"Inflation-adjusted wage growth is still not what we saw in the mid- to late 20th century, and we have years of slow wage growth to make up for," Wright said. "The hard part is figuring out why that's the case and what can be done about it."
Challenger pointed to automation and globalization as two key factors that have held wage growth down longer than it would have been in previous recessionary cycles.
Coombs cited research from the Federal Reserve Bank of San Francisco, which contends that many employers wanted to cut wages during the Great Recession but were unable to because of strong worker resistance and are now in a period of "pent-up wage cuts" that never transpired. "In the absence of those wage cuts, businesses laid off more workers and hired at lower rates to control costs," Coombs said.
HR Must Adapt
If wages continue to rise, it may result in some unintended adverse consequences for employers. Competition for talent is good for workers but makes it difficult for HR to find and keep workers and to control costs, Levanon said. "Wage growth is hitting the bottom line of many companies. Corporate profits in the U.S. peaked in late 2014." A higher quits rate and labor turnover is also hurting employers, he added.
"Another thing to keep in mind is that the era of the merit increase is slowly coming to an end, and you won't see across-the-board salary bumps very often in the future," Coombs said. "Many employers now use a total rewards approach to compensation, and they leverage their health care, retirement and flex work benefits as a means of recruiting and retaining top talent. Employers are also using one-time bonuses and variable pay offerings as a means of filling out workers' paychecks, rather than having the fixed cost of a merit increase on the books every year. And to some workers, flexibility and related benefits are more valuable than a salary that's at the top of the pay scale."
The hard question for HR when planning compensation is always "What is the right number?" Glaser said. "How quickly will ROI [return on investment] be seen from wage increases? In order for a business owner to make that decision, predictive analytics will be key. I think as 'big data' gets stronger, we will continue to see more talent acquisition professionals making the business case for wage increases."
Strong Growth Predicted
Economists predict that average wages will increase in 2017 at a faster rate.
"Barring any serious economic disruption, right now the most likely scenario appears to be a continued gradual rise in wages, as the labor market continues to tighten but overall inflation remains tame," Wright said.
Levanon puts growth at 3.5 percent, adding that wages are lagging indicators and have not fully reacted to the 2016 labor market.
"I think we've hit the time in the employment cycle when demand for workers outstrips supply," Challenger said. "The incoming Trump administration with its emphasis on fiscal stimulus and cutting taxes is going to spur the economy on in a period of already low unemployment."
Workers in fields that are in the highest demand—engineering, high tech, nursing—will likely benefit in 2017 from stronger increases in base pay than that experienced by the labor force overall, Coombs said.
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