| BUSINESSWEEK ONLINE : DECEMBER 13, 1999 ISSUE | ||||||||
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| ECONOMIC TRENDS
A Safety Valve for Wages? Variable pay's rewards--and risks Just when many experts had concluded that the Phillips Curve--the paradigm that links falling unemployment to rising inflation--was moribund, it has received a spark of new life. With the Federal Reserve voicing concerns that further shrinkage in the ''pool of available workers'' would touch off inflationary pressures and threaten the economic expansion, the financial markets are monitoring labor-cost trends with an increasingly wary eye. A number of economists, however, believe the Fed's focus on inflationary risks caused by tight labor markets is excessive. A study published by the San Francisco Fed bank in 1996, for example, concluded that price changes appear to predict future wages, ''while wage changes do not have much effect on prices.'' And a similar study published subsequently by the Dallas Fed found that inflation tends to precede rather than follow wage growth. Significantly, these studies focused on past decades when workers were presumably more aggressive than they are today because unions were stronger and globalization less advanced. Yet their findings suggest that any causal link between pay and price increases appears to run from inflation to wages, rather than vice-versa. More important, a new study by Federal Reserve Board economists underscores what could be ''a fundamental shift'' by employers toward flexible compensation. More and more are substituting production bonuses, profit sharing, hiring and retention bonuses, and stock options for regular pay hikes (BW--Dec. 6). Nearly 90% of companies recently surveyed by Fed regional banks offer some form of variable pay to nonexecutive employees. Noting that one leading measure of labor costs, the employment cost index, doesn't include stock-option grants, the Fed researchers estimate that its annual growth rate would have been 0.3 percentage points higher in recent years if their value had been counted. Even the more comprehensive measure of compensation per hour, which reflects the value of exercised stock options, understates potential labor costs when the volume of option grants is rising and markets are booming. The critical point, however, is that variable pay can blunt inflationary pressures. By linking pay to performance, it tends to enhance productivity. And because such payments can be cut when business worsens, companies may feel less need to raise prices. The fact is that current inflation readings remain benign, with core consumer prices up 2.1% on a year-over-year basis. And though it may be understated, labor-cost growth still seems to have decelerated since mid-1998 (chart). Unit labor costs also show no sign of acceleration, even after two years of unemployment rates below 5%. Still, some economists share a little of the Fed's concern. For one thing, flexible compensation is a trend whose staying power is still uncertain. Employees may not react well if and when such goodies are cut back or withdrawn. Moreover, as Richard Berner of Morgan Stanley Dean Witter notes, flexible pay has taken root in a low inflation environment fostered by ailing economies overseas and falling import prices. ''As these influences reverse and affect inflation expectations,'' he says, ''there's still a good chance that traditional wage increases will follow suit.'' BY GENE KORETZ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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RELATED ITEMS A Safety Valve for Wages? CHART: Labor Costs Seem to Be Losing Steam INTERACT E-Mail to Business Week Online | |||
