Higher Salaries and Bigger Skills Gaps Plague the Labor Market’s Recovery

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Aug 23, 2021

Inflation continued to surge in July with prices rising 5.4% from a year earlier, the highest 12-month rate since 2008. Despite continued statements by Fed Chair Jay Powell that the rise in prices is transitory, there’s little reason to believe that — unless “transitory” means two to three years.

The near- and mid-term effect will be to make compensation budgets swell as a tight labor market forces employers to pay more in wages and salaries, which already are rising at the fastest rate since the strong economy of 2018.

The most recent Survey of Consumer Expectations (SCE) conducted by the New York Fed showed that the lowest wage at which respondents would be willing to accept for a new job increased from $62,194 in July 2019 to $71,403 in March.

Meanwhile, economists project wage and salary growth to increase by 3.6% in 2022 and 4% in 2023. Employers will need to plan for bigger budgets since inflation has already eroded the value of most increases in pay: Wages and salaries increased 3.5% for the 12-month period ending in June, which is well under the rate of inflation. And price increases have outpaced compensation growth this year, causing real compensation to fall. In June, real compensation was 0.7% below December 2019 levels, and 2% below its pre-pandemic trend.

These are clear indicators that we’re already in the beginning stages of a wage-price spiral. With over 10 million workers still on the sidelines for reasons including a fear of the virus and lack of childcare, it will remain challenging for employers to fill their open jobs. The longer it takes to fill those jobs, the more companies will have to pay. Those higher salaries will inevitably lead to higher prices. And so on, and so on. 

The Emerging Labor Crisis

There is a labor crisis emerging that will make filling jobs harder for reasons that go beyond the pandemic. The U.S. ranks No. 29 behind other high-income countries in Europe and Asia Pacific on a number of digital economy skills, such as operating systems, cloud computing, and mathematics. The U.S. also lags in business skills like communication, entrepreneurship, and leadership and management. 

Many workers whose jobs were displaced by the pandemic were unable to shift to online work due to skill gaps. In the U.S.,1 in 3 workers lack the foundational digital skills to perform their jobs, and these gaps are particularly pronounced in many of the sectors that were most impacted by the pandemic, such as transportation, retail, and hospitality.

This situation is made worse by education access and affordability of college. The pandemic has led over 17 million high school graduates to cancel their college plans. Also, 75% of Americans believe that college is not affordable. Typically, only 24 out of 100 U.S. graduates earn a traditional four-year degree, and of those, 10 end up underemployed or working jobs below the level of their training.

The pandemic accelerated retirement, too. Around 2 million workers have left the workforce to retire since the start of the pandemic, and they are not being replaced by younger workers. This is more than double the number in 2019 and permanently reduces labor-force participation by about 0.4%. 

Rising Pay and Spending Will Fuel More Inflation

A shortage of workers and plentiful jobs have put workers in the driver’s seat in demanding higher pay. This comes at a time when workers are also flush with money from stimulus funds and enhanced employment benefits. 

While this could be great for business because people will spend more, it also keeps the fire lit under inflation. Paying more in wages and salaries raises business costs, which will eventually be passed on to consumers in the form of higher prices. If pay increases continue to accelerate, they will push inflation even higher.

So how does it end? The late economist Milton Friedman had said, “The only cure for inflation is to reduce the rate at which total spending is growing.” In an economy dependent on debt, and growth fueled by massive amounts of spending by the government, a drastic reduction in spending will result in a big increase in unemployment that could last years.

That is painful, but as Friedman noted, “These costs will be far less than the costs that will be incurred by permitting the disease of inflation to rage unchecked.”