Employment Cost Index: Labor vs. Capital …Tide Turning or Swirling?
The quarterly Employment Cost Index showed lower wage pressure at 5.1% YoY and a 4.0% annualized rate.
We look back across the past two cycles for Employment Cost Index frames of reference.
In the Labor vs. Capital trade-off, capital had been winning across two very distinctive cycles in the pre-crisis and post-crisis period before COVID and tight labor changed the rule of the game.
A downtick in anything linked to inflation is assigned a “positive” label, so in a sign of a “low bar” the 5.1% qualifies as good news just on the directional trend.
The ECI hammers home the sticky side of inflation in wage-price tradeoffs.
The Employment Cost Index (ECI) comes out quarterly. It is a broad measure of labor costs with extensive industry-level details on wage and benefit inflation. The 1.0% number for 4Q22 annualizes out easily enough to 4.0%. The YoY rate is 5.1% and catches the most headline attention. Over the years, the ECI is one of those indexes where you would glance at the headline (maybe) and then move on quickly. Monthly employment reports and CPI were the main diet for a sector coverage analyst with some side trips to narrower metrics depending on what you covered (e.g., Industrial Production for the manufacturing analyst, Retail Sales for the consumer analyst, etc.).
Back in the 1980s, macro metrics were big for sector analysts with the stagflation years a fresh memory and with Volcker seen as the equivalent of a monetary Robespierre. Greenspan was more about crisis mechanics as the inflation wars seemed to be mostly over. Greenspan faced myriad bank sector problems and credit market excess (see Greenspan’s First Cyclical Ride 1987-1992 10-24-22, Greenspan’s Last Hurrah: His Wild Finish Before the Crisis 10-30-22). The data-driven Fed of today’s world and the renewed priority of inflation have pushed macro metrics way back up the priority list again for everyone in the markets.
Most of us now are locked in on any metrics that give a read on cost pressures “from below” or any signs of slowing of pricing power “from above.” The ECI is released quarterly and fills in what we already know, which is that labor is tight and wages are rising. Wages plus benefit growth is coming off a rough two decades for total compensation across the national payroll ranks. The cable TV soundbite was labor was losing and capital was winning.
The broader causes are beyond this brief update, but the main events are pretty well known. The buildout of low cost supplier chains, erosion of manufacturing jobs, a swing to services, the rise of the machines (as ominous the movies made that phrase), demographics in a growing population, free trade deal side effects, and the consolidation across many industries all play into it. There is a longer list of factors by narrow industry groups with a laundry list of secular changes. A core element for many is simply labor cost.
The ECI history from the 2001 recession and TMT implosion through Dec 2022 is captured above. The back end of the 1990s boom into the 2001 TMT downturn ended on an inflationary note, but since then life was a challenge for worker compensation. That wage stagnation has been a hot topic for years but became a massive problem with the credit crisis that brought waves of restructurings and retrenchment. That meant minimal pricing power unless you were moving to shale country.
This recent trend has been heavily about supply and demand. The Federal minimum wage line has been stagnant since the 2007 legislation. The current minimum wage of $7.25 had been in place since 2009. We see 2009 as the low point on the chart above with Dec 2009 and 1.4% only six months after the recession trough. The 2007 legislation on minimum wage was the first hike since 1997. That was a political hot topic across the mixed power structures of the White House and Congress.
Attempts to increase the minimum wage have failed at the Federal level, but the cities and states took over. The end game for some was to see more business and investment migrate to other states. The fact that higher wage states usually pay more in taxes to “the feds” than they receive from the Federal government (the reverse is true in low wage states) is a separate discussion. Life is not fair. Neither is politics.
The wage inflation pressures we have seen in more recent years brought relief on the nominal side of the ledger, but the purchasing power of workers eroded in 2022. The “relief” of 5% handle wage increases to end 2022 and any related benefit increases thus comes with an asterisk. As shown in the chart, the very slow post-crisis recovery in jobs during Obama’s first term took protracted ZIRP and a few rounds of QE to get the employment part of the dual mandate up to par. The median unemployment of 5.4% and median ECI inflation of 2.8% are there to use as a frame of reference. As of now, wages and benefits are above median and unemployment well below median. That does not make for a bad consumer story into 2023 even with some setbacks assumed.
The chart above gives a closer view of the ECI cost trends without the unemployment line. This scale offers a more realistic visual on how much the wage/benefits costs have swung around and how quickly. The sharp move higher in 2022 is more about mitigating inflation damage for the workers, and that is where the wage-price spiral term gets into play. Workers’ purchasing power is still falling behind and especially against CPI as a frame of reference (see CPI Wrap for 2022: The Beginning of the End? 1-12-23). In terms of the employer P&L, the wage increases by definition affect something, and that “something” is either the profit margins or revenue line (i.e. price). That in turn can set off the wage-price spiral dynamic.
There also can be a plan for increased productivity (getting more output per head) or realigning the supplier chain. That means less headcount to deliver a given set of goods or services. In other words, that wage pressure can translate into lower payroll at the macro level. That wage weakness or lack of pricing power over the past two decades is where progressives criticize trade deals with low-cost countries and where China hawks talk more about tariffs. Those are all topics for other commentaries since it will be a big item ahead of the 2024 elections. The ECI history of moving parts also creeps into Federal State and Local politics – notably in minimum wages by city or state.
The chart above offers another angle that frames the private sector vs. state and local. The private sector had lagged the public before the crisis. The private sector is now leading the ECI metrics higher in the post-COVID period. The immediate post-crisis period was more an ebb and flow across the Obama and Trump years. We did not do an industry by industry review for those years for this write-up, but auto sector pain, the bank sector strains, oil price volatility and the recovery from the housing crisis were all going to take time to work through.
Job protection and favoring domestic industries is a mixed picture. The more protectionist Washington tone on tariffs was actually started by Trump with an assist from progressives like Bernie Sanders (he hates free trade deals). The flip side is that tariffs are inflationary by definition and ease the pressure on labor by taking away the “race to the bottom” effect from low-cost countries. This is the case whether in China (wide range of imports) or in Mexico with its low-cost labor advantage in assembly plants (assembly of everything from PCs to autos). To highlight the differential, skilled and semi-skilled labor workers in Mexican auto plants are paid a fraction of US wage rates. Mexico’s minimum wages in manufacturing are less than half the US minimum wage.
The basic foundational reality right now in the US private sector is that labor pricing is bypassing politics (i.e., minimum wage laws) and going straight to supply and demand forces for worker raises. The JOLTS report that comes out monthly tells a story of tight labor (see Employment: JOLT Stats Offer a Yawn 1-4-23, Jobs and the Fed: JOLTS Gets Heavy Powell Focus 11-30-22 ). Supply-demand rules in every market. That may even be the case with the government jobs these days with so many labor shortages. The public sector jobs often have an advantage on benefits.
The varied stimulus packages around infrastructure and climate friendly initiatives will be positive in setting a lower trough floor on labor demand. Cash is being directed toward those areas, and the bodies will follow. Regardless of whether such bills are deemed inflationary or protectionist, they make a better case for labor than the absence of such fiscal support.
The ECI release from the BLS comes with a range of tables and line items by industry/job category and make for an easy scan. The main takeaway was that there was not much variance across the major groupings of “All workers” vs. “Goods” vs. “Services.” Education and Health Services saw minor ticks higher in 4Q22 than the overall ECI. Finance and Credit Intermediation and Information Services were also higher. Many lower paying services occupations with material job openings tend to have an easier time moving the needle just on the low denominator effect.
Among line items that jumped out included 6% YoY handles for sales and office support. We also saw 6% handles in Nursing and Residential Care. Leisure and Hospitality are also in the 6% handle mix. Services with labor intensity need to pay up to fill jobs.
Unionization rates do not tell the broader wage increase story…
Some of state and local governments are in many ways the last bastion of the powerful unions. The total unionization rate in the workforce was 10.1% in 2022, which was the lowest on record. The public sector unionization rate was 33.1% or a multiple of over 5x the private sector rate of 6.0%. Those unionization rates are updated annually in January by the BLS.
The to-and-fro on what unionization rates mean will rage unchecked for as long as there are political advocates. That includes in the private sector, where the unions are clearly losing across the decades. For example, the auto industry remains the most powerful of the manufacturing unions, but the UAW has never been able to carry the vote of major transplant operation work forces. Everyone accuses the other of bad behavior, but votes are votes.
There is not much mystery in the direction of the tides in union rates. Among the largest states, New York tops the list at 20.7% with California at 16.1%. We see Texas at 4.1% and Florida at 4.5%. That gap is no surprise. As the decades go by, however, the fact that Michigan is only 14.0%, Ohio only 12.8%, Pennsylvania at 12.7% and Wisconsin at 7.1% speaks to a lot of the shifting political tides on the critical swing states that determine who is in the White House. Those stated have also felt the fallout of declining manufacturing. Michigan, hub of the auto industry for so long, and Wisconsin, which has seen major downsizing of its manufacturing base across the decades, even joined the ranks of the Right to Work states during the Obama years even as he carried both states.
The chart shows how government jobs were rising faster than private sector earlier in the timeline and now the private sector is rising faster. Many would attribute the private sector wage lags and stagnant wage/benefit growth to automation and corporate restructurings, China, and NAFTA (now USMCA). Some attribute it to the erosion of unions in the private sector and migration of manufacturing to “right to work states” (read “union averse”) even as the secular decline of US manufacturing was ongoing (read “China” and “Mexico”).
In explaining the slow and steady stagnation of benefit trends over time, some highlight weaker health care and pension benefits broadly as the old school defined benefit pension plans gave way to defined contribution. Retiree health care benefits were often eliminated entirely. The blame game debates will continue, but there is every reason to believe ground zero in the defense of domestic labor will be in trade policy with a hostile China-focused trade strategy (see State of Trade: The Big Picture Flows 12-18-22).
Those geopolitical and domestic political angles will not loosen labor markets. The reverse effects could be more likely since there will be more operations onshored depending on the industry. We always go back to the basics that supply-demand drives wages just as it does everything else over the longer term. In other words, the wage trend from here will have a range of competing forces in play. The recession nerves are more immediate as Fed tightening looks to reel it in.
The pressure from low unemployment and many job openings detailed in the JOLTS report make the downtick in the ECI for the Dec 2022 quarter hard to extrapolate from in terms of the Fed policy actions. The 5% handle is too high for them perhaps but the 4% handle run rates (4Q22’s 1% x 4) are on the cusp. The theory at the Fed might be that demand needs to feel more destruction from interest rates in the broader economy that will flow into the pricing power of the work force. They won’t say that with their outside voices, but we will hear more hints tomorrow in the Powell press conference.