Employment costs rose 0.7 percent in the third quarter and are up 2.5 percent over the past year. A tight labor market points to further strengthening ahead.
Compensation Costs Quicken in Q3
In another sign of a tight labor market, employment costs rose 0.7 percent in the third quarter. At 2.5 percent, the employment cost index (ECI) is just shy of the post-recession high hit briefly in 2015 and is ahead of the 2.3 percent increase registered this time last year.
The third quarter increase was driven by a pickup in both wages & salaries and benefits. Wages & salaries rose 0.7 percent, one of the strongest quarterly gains this expansion. Excluding incentive paid occupations, wages & salaries rose a bit more modestly (up 0.6 percent), but have increased in line with all workers at 2.5 percent over the past year. Growth in wages & salaries was led by the private sector, with particularly strong gains in professional & business services, manufacturing and transportation & warehousing.
Wage costs in the private sector continue to outpace the government sector. In contrast, benefit costs continue to rise more quickly for government workers, up 0.8 percent versus 0.7 percent for private sector workers in Q3. In recent years, benefits costs have been growing more in line with wages & salaries as employer spending on health benefits has slowed to its lowest rate on record. This may be due in part to employers passing more of the cost burden onto employees and/or employees switching to slimmer plans in an effort to reduce their own spending on healthcare.
Employment Costs Expected to Pick Up Further
The strengthening in employment costs, particularly the wages & salaries component, is consistent with the firming in average hourly earnings. Looking at the drivers of both average hourly earnings and the ECI, we expect to see wages and compensation costs pick up over the coming year. The unemployment rate has fallen below both the Fed and Congressional Budget Office’s estimates of full employment, indicating labor has become relatively scarce. That scarcity has been echoed in the share of small businesses reporting that they have at least one hard to fill job opening.
While at cycle highs, the quit rate implies a more moderate pace of strengthening in compensation as it has moved sideways since the start of the year and remains a bit below the levels of the past expansion. Voluntary quits tend to be associated with higher wage growth as most workers do not switch jobs without being offered higher compensation. Indeed, the Atlanta Fed’s Wage Growth Tracker shows the typical job switcher has seen earnings increase nearly a full percentage point faster than job stayers over the past year. The extent of the upturn in employment costs will also be limited, however, by low inflation expectations. Without much pricing power, businesses will remain cautious about raising compensation.
