| BUSINESSWEEK ONLINE : MAY 17, 1999 ISSUE | ||||||||
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| BUSINESS OUTLOOK
U.S.: The Win-Win in Slowing Labor Costs It's a boost for profits--and consumers still have plenty in their pockets Economists must be feeling like Lewis Carroll's Alice about now. On their trip through this economic Wonderland, they have watched superheated growth and falling inflation coexist for three years. And now, yet another paradox has arisen: Amid the tightest labor markets in a generation, wages and benefits of American workers, which had been accelerating since 1994, have suddenly begun to slow down. Curiouser and curiouser. The sharp slowing in the Labor Dept.'s employment cost index (ECI) for the first quarter stunned economists (chart). The index, which measures hourly wages, salaries, and benefits, increased only 0.4% from the fourth quarter of last year, about half the expected rise. Measuring from a year ago, the index rose 3%, down from a peak annual pace of 3.7% two quarters earlier. Pay growth has slowed even as the Commerce Dept. reported that the economy grew at a robust 4.5% annual rate in the first quarter, following its 6% pace in the final quarter of 1998. The wage slowdown appears to have continued into the second quarter, based on the Federal Reserve's latest survey of regional economic conditions through Apr. 26. The report noted continued tight labor markets in most areas, but that ''these conditions were not often translating into higher wages.'' The broad explanation of this surprising trend in compensation is that persistent low inflation is altering the wage-setting process to the benefit of companies without exacting a severe toll on workers. The lack of pricing power, together with its drag on profits, is forcing businesses to cut labor costs. But at the same time, low inflation is giving workers a sizable boost in the buying power of their pay, especially compared against the paltry performance of real wages in the 1980s and most of the 1990s. BUSINESSES' INCENTIVE to hold down wage growth is clear: Raising prices is difficult, especially in manufacturing, amid weak exports and import competition. That's the major explanation why last year was bad for profits generally, despite a very strong economy and excellent productivity growth. Although 2.2% productivity growth in the nonfarm sector held unit labor costs to an increase of only 1.9%, the 0.7% rise in prices in this sector could not cover costs. As a result, profits got squeezed last year, and the slowdown in pay growth is a key reason why first-quarter profits looked much better (page 128). But while it is easy to understand businesses' motivation to cut costs, it is odd that workers are so accepting of smaller pay gains, especially at a time when demand for their skills is soaring. Again, low inflation is part of the answer. Declining inflation last year, led by falling oil prices, pushed workers' real wages up by more than 3% by some measures. That pace was far greater than the productivity gains workers were giving employers in return. Companies are now bringing pay growth into line with both productivity and low inflation. Although that means workers' real wages are slowing, the pace in the first quarter was still a healthy 2%, based on the inflation-adjusted ECI. OTHER FACTORS ALSO EXPLAIN the apparent acquiescence. First of all, the first-quarter slowdown in the ECI was exaggerated by the slump in bonuses in the finance industry resulting from last year's market turmoil. However, even after adjusting for special factors, the deceleration trend is still in place for both wages and benefits. The slowdown in benefits seems at odds with anecdotal evidence that health-care costs are speeding up, but companies evidently are finding ways to cope. Another reason workers are accepting smaller pay gains: the massive layoffs in manufacturing, which have probably reignited some job jitters among factory workers. In the past year, factories have slashed overtime, and they have cut some 400,000 workers from their payrolls. The hourly pay of production workers is up less than 2% from a year ago. Last year at this time, annual pay gains in the sector averaged 3%. Also, the Fed reported that ''firms are increasing nonwage compensation...and are using hiring and retention bonuses to attract and hold onto skilled workers.'' Indeed, given the stock market's bull run, more companies are offering stock options in lieu of pay raises. Options don't show up in the government's employment cost index. And finally, to have a life outside of work, many workers may be willing to sacrifice bigger pay raises for more flexibility in their work schedules. DESPITE THE SLOWDOWN in pay growth, consumers obviously are still having the time of their lives. The power behind the first quarter's 4.5% advance in gross domestic product was a 6.7% surge in consumer spending, the largest quarterly increase in 11 years. The uptrend in consumer outlays has accelerated sharply over the past year, as has households' real income. Although wage rates are generally slowing, payrolls are still expanding at a good clip, resulting in a 3.7% advance in real income during the past year, the strongest showing in four years. That still leaves a sizable gap between income and spending that is being filled by stock market gains and a reacceleration in consumer borrowing (chart, page 31). One notable point is that, despite the gap between spending and income, wages and salaries alone, about three-fifths of overall income, have been growing greater than 5% adjusted for inflation. Other types of income, especially interest, have been growing much more slowly than wage income. The upshot: The 133 million Americans who have jobs are increasing their spending in line with the buying power of their incomes. But consumers had help in pushing up domestic demand at an exceptionally strong 6.8% clip last quarter. Housing grew by a weather-boosted 15.6%, and capital spending made a surprisingly large contribution to growth last quarter. Business investment in equipment grew at a 10.5% annual pace. However, a lot of that demand was satisfied by imports, which surged an additional 11.7% in the first quarter, while exports fell at a 7.7% pace, wrestled down by the global downturn. The resulting massive widening in the trade deficit, by itself, subtracted 2.4 percentage points from growth (chart). That drag will continue as long as domestic demand, led by consumers, remains robust. On balance, the slowdown in labor costs is a win-win situation for the economy. The new trend will help to sustain this expansion by buoying profits. It will keep consumers spending--if a bit more slowly. And it will ease fears that overheated economic growth and labor markets would cause the Federal Reserve to raise interest rates. That should leave consumers, businesses, and investors grinning as broadly as the Cheshire cat. BY JAMES C. COOPER & KATHLEEN MADIGAN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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RELATED ITEMS U.S.: The Win-Win in Slowing Labor Costs CHART: A Curious Slowdown in Compensation CHART: Strong Income Gains, Even Stronger Spending CHART: Trade: A Huge Drag on First-Quarter Growth INTERACT E-Mail to Business Week Online | |||
