The Economy's Effect on Compensation

By Ryan Funsch and Mary Rizzuti

The economy is top of mind for most Americans. Inflation, fears of a recession and historically low unemployment have employers and employees looking ahead with uncertainty.

Compensation causing inflation stabilization?

According to a recent New York Times article[1], the economic outlook is beginning to brighten, and smaller wage increases are partly responsible: “Fed officials have repeatedly argued that it will be hard for inflation to fall back to their long-term goal of 2% as long as wages keep rising at a rate of 5% or more a year, as they have been since the middle of 2021.” However, in the final three months of 2022, wages in the private sector increased by just 1% (equal to a 4.2% annual growth rate), thus showing signs of easing inflation. It’s too soon to tell, but with the recent wage numbers and other economic data released, inflation could continue to fall.

While job candidates may continue to negotiate for higher salaries, it appears that employers are beginning to pull back on above-market compensation in many functional areas. With recent company-wide layoffs by some employers, we could experience a shift from an employees’ market to an employers' market where talent is concerned.

Cost of Labor vs. Cost of Living

Compensation levels are typically aligned with the Cost of Labor, i.e., what an employer has to pay for a certain job in a specific market, as opposed to the Cost of Living, which is driven by inflation, aligning with supply and demand for goods and services. However, many employees don’t realize that difference.

For that reason, focused communication to educate employees about how their compensation is determined goes a long way. Many employees expected a 9% increase when inflation was at 9%. The companies who took a proactive approach to conducting market studies and communicating their compensation methodology and philosophy had positive outcomes of performance evaluations and merit increases.

Compensation Changes to Consider

Companies may wish to think about a more modest approach, both in merit increases for this new performance cycle as well as in new hire offers, in order to normalize the compensation of staff. Employers may also consider offering additional compensation in a performance-driven model (e.g., annual bonus, spot bonus, milestone bonus), as well as offering other work/life perks as we navigate through new and varied approaches to where and how employees work.

[1] https://www.nytimes.com/2023/02/02/briefing/wages-inflation-economy.html