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Feb 28, 2022

Cast your mind back (if you can), to 1978. Grease was the top-grossing movie; there were only three TV networks, and Laverne and Shirley was the most TV watched show. But there’s something else. It was also the last time inflation was as high as it is today – an eye-watering 7.5%.

To those for whom the 70s was before their time, wages matched inflation almost perfectly. Workers successfully pressured employers to increases their pay packets to cover increases in the cost of living. Employers responded by raising prices to cover the cost of increased wages. It sort of worked.

It’s a situation we’re also seeing repeated today. Wages are (almost) increasing along with inflation, rising 5% over the last year. In the 1970s inflation resulted from massive increases in spending by the Federal government on social programs and the Vietnam War. Interest rates were kept low for a long-time to ensure there was plenty of credit. The result was a surge in demand for goods and services that far exceeded the supply. The same is happening today. Stimulus payments and extended unemployment benefits have left workers flush with cash; estimated to be $2.7 trillion in excess savings at the end of 2021, while interest rates have remained low.

So has a new wage spiral started?

Evidence suggests trends for rising wages are unlikely to change anytime soon. This year salary rises will be the highest since 2008, while compensation budgets are estimated to increase 3.9% ­– driven by increases in wages for new hires and increased inflation. Continued labor shortages and elevated inflation will also keep up the pressure for cost-of-living adjustments. While rising inflation doesn’t always produce a wage-price spiral, this time round it’s looking much more likely.

It’s worth pointing out wages and salaries were already rising – even before the pandemic – as employers struggled to hire workers.

Workers in sectors like construction, transportation, manufacturing, food service, leisure, and hospitality enjoyed the highest increase in wages for decades. This continued as the labor pool shrank and demand skyrocketed during the pandemic and employers provided wage hikes and sign-on bonuses.

So while the labor-market and the economy are different today than they were in the 1970s, two main factors could tip the labor market into a wage-price spiral:

1) The bargaining power of workers:

Today workers have a lot, as the labor shortage is forcing employers to bid up wages. An increase in the labor-force participation rate may moderate this, but there’s no sign this is happening yet. The reported increase in the rate this January was more down to changes in population estimates made by the census. In other words, there was no increase. While Omicron is retreating, another variant could still cause a surge in cases and hospitalizations, which could cause more workers to withdraw from the labor force and discourage others from rejoining. This would worsen the labor supply leaving employers with no option but to bid up wages even more.

2) Further rises in inflation:

In the 1970s OPEC embargoed sales of crude oil to the US, causing energy prices to surge. Companies responded to increased costs by raising their prices even more. Back then the labor force was much more unionized – about a third of all workers belonged to unions. Union contracts typically included cost-of-living provisions that triggered pay raises when inflation rose, which also were extended to non-union workers. A wage-price spiral developed as workers and companies began planning for price and pay increases because they expected costs would keep going up. Even though unionization is much less common today (only 6% of workers belong to unions), if inflation becomes more entrenched then a wage-price spiral may be inevitable.

Now there’s no guarantees:

Both these factors are significant in their own right. What could make things worse is an unexpected external shock – such as a natural disaster that impacts manufacturing and supply chains (like the tsunami and earthquake in Japan in 2011), or another Covid outbreak in China that shuts down manufacturing and ports.

What happens next depends on the supply of labor, and of goods and services. Labor-force participation may increase as workers spend down their savings accumulated during the pandemic. Manufacturing may ramp up and logjams at ports may clear.

But none of this is guaranteed, and nor will any of these trends change quickly. Most CEOs expect high Inflation to last into 2023 and consequently there being sustained upward pressure on wages.

The labor market may not be in a wage-price spiral yet, but it’s getting pretty close.

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