What Causes Wages to Rise?

November 28, 2017

 

We've been hearing a lot of debate around wages lately, because we've seen an unusual phenomenon in the labor market recently. We're near so-called 'full employment' (we consider full employment a 4.0% unemployment rate), but wages have not risen to match the demand. Why is this? One reason I suspect is that there is a lot more competition in the market than the statistics reveal.

 

Brace yourselves, the nerding has begun.

 

While we celebrate a 4.1% unemployment rate, we know there has been a steady drop in the Labor Force Participation Rate. The number of people who could be working, but aren't, has been rising steadily over the last eight or so years. It should not be ignored that the economic recovery during that time has been real, but it has not been complete. In addition to this, as I've talked about before, employee engagement in the US stands at a paltry 33%. Those people - up to two thirds of people currently working - are looking for jobs, but they are not reflected in the unemployment rate. That's unreal!

 

There is still plenty of competition for jobs out there that isn't reflected in the unemployment rate. That's a big consideration if you're currently looking. It's also a consideration for employers. They have their pick of great candidates, so they don't have to dangle huge salaries to attract the best and brightest. In fact, the largest segment of the workforce by age is Millennials, and they are more likely to leave a job for a new challenge, culture or work-life balance than a big salary. No wonder companies aren't chasing people with money.

 

On the other hand, we do all want to have good, regular wage increases, or what we in the HR world call a COLA (cost of living increase). The average raise in the US this year was 3%, and is expected to be the same next year, but average means there are plenty who do more, and plenty who do less. Compare that to the rate of inflation this year, which stands at 1.7% so far, and is predicted to be 2% next year. It's almost like cutting that raise in half. How much did your rent go up this year? What about your cable bill?

 

So let's get back to the original question - why do companies raise wages at all? The big debate going on at Capitol Hill right now is over the tax bill. The argument goes that a tax cut to corporations will result in those companies passing the money on to their workers. Here's the first thing you should know: companies exist to make money for their shareholders or owners, full stop. They serve customers to return revenue, which makes money. That's it. So the idea that an influx of money would be given away is odd on its face.

 

But let's follow the logic for a moment. There are a few times in history when companies have been given big tax cuts. Have there been concurrent wage rises? At the risk of sounding negative, no. Well, let me be a bit more effusive on the matter. I put together a chart that took the average household income, broken out by income bracket, overlaid with when we had two rather large tax cuts in that same period of time. As you can see for yourself, if there were any large income gains to be had, it was solely for those in the top two income brackets, and it doesn't seem to be correlated with those tax cuts. In fact, there was an income drop after the Bush cuts. Everyone else in the lower income brackets saw flat, or insignificant, income gains in that time.

 

 

So, why is this? Companies get a nice chunk of money to play with. Why doesn't that trickle down? Because companies don't raise wages just because they have extra money laying around. Tax cuts, on a balance sheet, are not revenue. They are simply the elimination of an expense.

 

So, what does make companies raise wages? In my experience, there are a few reasons:

 

1. It's a competitive advantage. Companies need good workers to ensure the clients get served, the widgets get made, and business processes occur. Wages are an important part of a satisfied workforce, but as I've mentioned in my book, they eventually have diminishing returns. You could pay someone a seven figure salary, but if they have a terrible manager, poor working conditions and other hygiene factors, as we HR practitioners call them. So there must be other sweeteners that make working somewhere worthwhile. A business must have a pay strategy, and part of it is paying competitively with your industry peers. You might want to pay slightly more, to attract certain workers, or pay slightly less, but offer a significantly more attractive fringe benefits package to make up for it. There are a lot of factors that go into a pay strategy, and budget is certainly among them, but suddenly having fewer expenses doesn't make the company go back to their strategy and rethink it.

 

2. Regulatory changes. Businesses can often be compelled to pay more thanks to changes in pay strategy. In New York, for example, the minimum wage regulations were recently changed, and are on track to be $15 per hour in most places in the state in the near future. In order to comply, businesses must change their pay strategy. This will not only force those companies to pay their lowest paid workers more, but they will also need to reexamine many other workers who are paid just above that level. This is called pay compression, and it often causes a rethink of the entire strategy.

 

3. Social pressure. Walmart's current struggles are a great example of this. They were perfectly compliant with the law, and they had no problem finding workers for their minimum wage roles, but when a photo of a donation box for their own workers went viral, they found themselves caught out. Paying their workers minimum wage, in some locations, meant their workers qualified for food stamps and other benefits, which seems counter to the intention of those programs. It also feels like a corporation is asking taxpayers to subsidize full-time workers. All the bad press caused them to go on an apology campaign and raise worker wages.

 

4. Collective bargaining. This is one of the prime reasons why unions claim to exist - to fight on your behalf for better wages, benefits and working conditions. Surely, there have been high-profile cases where unions have won significant battles on behalf of workers. It's hard to imagine that Walmart would have been able to get away with their pay practices for as long as they did if a union were present, which is probably why they fight unionizing so hard. The challenge comes when a business, of its own volition, chooses to raise wages thanks to one of the preceding three reasons. The union doesn't generally let it happen without inserting itself into the process so it can demonstrate it holds influence and is the cause of any improvement for workers.

 

There is a final reason why a company raises wages - and it's because an individual asks for a raise. This can be a big challenge for a lot of people. In the first place, talking about money can be awkward and difficult. Secondly, in a world where workers are so highly commodified, it can be easy to think that a company can so easily replace you that it would be easier not to make waves than to ask for money. Subscribers, I've got some of my top tips on asking for raises coming to you on Friday, so be on the lookout for the newsletter.

 

So, that's my very long-winded opinion on this tax bill, and what actually raises wages. What's your take? Leave me a comment below.

 

 

 

 

 

 

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