Almost all U.S. employers plan salary increases for 2022, and most are planning their increase between 5% to 6%, according to compensation consulting firm surveys. 97% of CFOs said labor costs will increase significantly by 2022, as reported by Deloitte’s fourth-quarter CFO Signals survey.
There is a fierce battle for talent among top firms, and employees are demanding higher pay as inflation increases. In fact, according to some reports, Apple is paying its engineers a rare $180,000 bonus to keep them from going to rivals.
Although the Federal Reserve notes wage inflation will be a factor to watch in 2022, it still isn’t one of the primary factors driving inflation.
There are economists who are not as confident as the central bank, that rising wages do not contribute to the wage-price spiral, in which wage inflation leads to higher prices, and higher prices lead to increased salaries.
“It is here,” explained Lynn Reaser, chief economist at Point Loma Nazarene University, and professor of economics.
“You’ve seen it in the restaurant industry, not only the price increases in the cost of serving meals from the ingredient side, but from the attempt to desperately recruit new workers, and restaurants passing it along to customers in the form of higher prices.”
The pandemic is not only affecting the restaurant industry, according to Reaser. Producers supplying grocery stores are ordinarily testing how much they can raise prices, and labor costs are one of the factors forcing them to consider higher prices. November has marked the fastest increase in producer prices on record.
“A wage-price spiral has started,” Professor of finance and economics Sung Won Sohn, head of SS Economics at Loyola Marymount University, wrote.
Nonetheless, in the market where businesses are not afraid to raise prices, “the spiral, once begins, it is hard to stop,” he noted, pointing out how higher labor costs are being passed along at little or no cost to consumers, as stated by Atlanta Fed.
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Fed Chair Powell Focuses More on Wages than ever Before
The Federal Reserve stated that its actions are now more closely linked to wage inflation as Chairman Powell spoke more about the issue.
“If you look at the state of the economy … the strength of demand, the strength of just overall demand, the strength of demand for labor, look at inflation, look at wages … moving forward the end of our taper by a few months is really an appropriate thing to do,” Powell said, but he did not claim there was a wage-price spiral.
“Wages have also risen briskly, but thus far, wage growth has not been a major contributor to the elevated levels of inflation” he added. “We are attentive to the risks that persistent real wage growth in excess of productivity could put upward pressure on inflation.”
The wage dynamic is affected by multiple factors, some of which may ease in the future, but not all of them.
Reaser said that restrictions on immigrant workers are partly to blame for wage inflation, as they cut off a significant escape valve for wage pressure and competition among existing workers. It affects employers in many industries, including technology, healthcare, leisure, and construction. It is a problem at all income levels, including low-, middle-, and high-income.
After the economic depression and the pandemic created a large government safety net, more Americans looked at their work-life balance and retired. During the pandemic, people retired in record numbers, which means the labor shortage won’t be alleviated very soon.
But despite the recent pandemic, the U.S. labor force has slowed in recent years, and this trend could worsen. Labor force growth in the 1980s was 1.6% per year. This could approach zero in the coming decade, according to him.
“These will mitigate to some extent, but wage inflation is now the dominant risk,” Reaser explained.
Despite the upward pressure at the bottom end of the pay scale, she is concerned that it may also push upwards higher brackets.
“Maybe not all the way up to management, but mid-income, as their margin over less-skilled employees will have shrunken in terms of wages,” Reaser continued.
“There will be pressure on those people to ask for larger wage increases so they can keep their margin over lower pay workers.”
Vicious Cycle of Rising Wages and Rising Prices
“It is a vicious cycle,” according to Gad Levanon, head of the Conference Board’s Labor Markets Institute.
At every stage, the wage-price spiral is self-perpetuating, with both sides feeding off of each other. Inflation, in turn, leads to higher wages, which causes more inflation, which impacts wages again.
According to a recent survey by the Conference Board, 39 percent of companies stated that inflation influences salary budget increases for 2022.
“That’s a meaningful share,” he declared.
“From conversations I have with HR and compensation professionals, they are definitely now talking more about cost of living adjustments than they did before. When we talked about COLA even six month ago, it was ‘something we did in the 70s and 80s.’”
There has been an impact of prices on wages and wages on prices for some time, Levanon said.
“Now, more than any other time in recent decades,” he added.
However, Levanon argued that it’s not clear if wage inflation can be separated from the other aspects that determine inflation, which could ease later this year. He later implied inflation would spiral out of control.
“There are a lot of other determinants of wages and inflation, such as the supply chain, and what will happen with it in 2022, and how fast demand grows. As well as how many people come back into the labor market,” he continued.
Powell stated that the FOMC participants’ median inflation forecast for this year drops to 2.6% next year, which is “notably higher” than the September forecast.
“So far, we don’t see, wages are not a big part of the high inflation story that we’re seeing,” he said.
According to Reser, even if supply chain issues are resolved in the near future, the Federal Reserve will face another dynamic ground in 2022 when inflation has already migrated strongly to wages.
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“Workers will be seeing and believing inflation will be staying higher and the risk the Fed has always guarded against was that inflationary expectations become unanchored, and certainly, they’ve started to become unanchored. That sets off demand for larger wage increases on the part of all workers and that starts a wage-price spiral,” she stated.
Levanon concluded that 4% to 5% inflation is not the end of the world, but it poses a serious threat to the Fed’s efforts to anchor inflation expectations at a lower level in recent decades.
“I think the biggest risk is that expectations about inflation will continue to rise and the more they rise, the more difficult those expectations are to manage,” Levanon added.
“It was a hard-earned accomplishment for the Fed to able to anchor inflation expectations, and they are at risk of losing it.”
There Are Concerns Among CEOs And Wall Street
Business owners are also upset. Data published by Business Roundtable shows that wage inflation is hurting CEO confidence, and Wall Street analysts are looking at 2022 stock evaluations based on a company’s ability to pass on labor costs.
“Wage inflation is the issue I would focus on,” David Kostin, U.S. equity strategist for Goldman Sachs, said in a recent interview with CNBC.
“That’s a headwind that is going to persist,” he declared.
Those price increases cannot be passed on to customers in perpetuity without losing customers to competitors. In addition, Levanon said customers didn’t consider switching to a different provider when costs rose by 2% a year, but when prices rose by 5% – 6%, they started to think twice. A sharp rise in prices can force businesses and consumers to rethink their relationship with each other and with each other’s businesses.
While these wage dynamics occur during a time of lagged productivity growth, which predates the pandemic, the effect is amplified while wages are rising.
Companies can squeeze their profits, but no wage increases for workers — demanded by the workers themselves — could lead to further churn in the labor force, increased training and hiring costs, and elevated quit rates. The companies can offset wage inflation by raising prices or increasing productivity, but these actions are limited on both sides, and new productivity measures take time to come into effect.
“Executives you talk to are worried about the larger wages they have to offer and talk about investing in new productivity measures, which will take some time. And they are trying to test the waters with price increases while they work on productivity gain measures,” Reaser said.
According to Levanon, many companies said they cannot pay their employees more because they want to protect current profits. However, it is likely that wage growth will further split the business world between the haves and have-nots, allowing the most profitable and productive businesses to limit the cost increases while still maintaining their market leadership. The company may not be as profitable if it does not pass on more costs to the consumer. In turn, this could cause a widening of the productivity gap between the most and least productive companies.
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Wages are Consistently Higher
“Powell does not want to ring alarm bells, but he does have to bring some acknowledgment that wage pressures are becoming a much bigger part of the inflation picture,” Reaser explained.
“And will have to be monitored even more closely. The risk is the Fed may have to be more aggressive in 2022 than previously communicated, with even more rate hikes than currently forecast.”
According to Levannon, the Fed policy and communication will remain crucial in determining “whether this will spiral or not. … Having rates at zero is not the right thing to do.”
In 2021, Powell will have gotten rid of the “transitory” definition of inflation. It may be that “persistently” and wages will be the biggest semantic issue in 2022, with big consequences for the economy.
“As you look forward, let’s assume that the goods economy does sort itself out and supply chains get working again, and maybe there’s a rebalancing back to services. … But what that leaves behind is the other things that can lead to persistent inflation,” Powell stated following the last FOMC meeting.
“If you had something where wages were persistently — real wages were persistently above productivity growth, that puts upward pressure on firms and they raise prices, it would take something that was persistent in material for that to happen. And we don’t see that yet. But with the kind of hot labor market readings — wages we’re seeing, it’s something that we’re watching.”
