Food prices are up, rent prices are up, and gas prices are so high that Uber and Lyft drivers are considering quitting. Inflation is 7.5%, the highest it’s been since 1982. Yet it’s unlikely that wages will rise correspondingly.
According to a March 2022 study by Mercer, a human resources consulting firm, 45% of employers don’t factor inflation into salaries and less 25% said they will be making changes to their salary budgets because of inflation. Yet the same survey found that 77% of respondents cited compensation as their main reason for turnover. Given that we’re also in the midst of the Great Resignation—where record numbers of employees are leaving their jobs—why aren’t more employers raising wages?
Mainly because employers just aren’t used to factoring inflation into wages. In the 1970s and 1980s, when inflation rates were in the 3-14% range, wages were closely linked to inflation, says Jason Furman, a professor of economic policy at the Harvard Kennedy School. Starting in the 1970s, labor unions pushed for contracts had clauses that included cost-of-living adjustments. However, as inflation rates stabilized, 3% salary increases for cost-of-living became the norm.
Furman points out that while most employers discuss salary budgets for the coming year in September, it wasn’t clear to most people last fall that inflation was here to stay. “If you were a company in October last year, it wasn’t crazy to believe that inflation was transitory,” Furman says. “Now it’s clear we’re going to have another year of inflation, and probably several more.”
He thinks it’ll take some time before employers manage to adjust to the new inflation-normal and adjust wages accordingly.
The problem with market rates
Today most employers set wages based on the market. According to Tony Guadagni, a senior principal at Gartner, most larger organizations pay vendors to conduct surveys on prevailing market rates for different roles. Based on those rates, they’ll set salary bands that allow salaries to be adjusted 15-20% to account for academic credentials and experience. However, these rates aren’t based on cost of living—they’re based on existing demand for a role.
Guadagni points out that employers have reason to be cautious before committing to inflation-based increases. Once they do this, employees will expect them to sustain the same wages. “If the past three years have taught us anything, it’s that anything could happen,” Guadagni says. “Employers would rather not be in a situation where they can’t sustain an inflation salary.”
Even though employers say they aren’t taking inflation into account, salary increases are actually the highest they’ve ever been as organizations scramble to retain workers in the midst of the Great Resignation. Typically, employees who stay at a job or switch see increases of 4-5%, according to a study from ADP with data dating back to 2014. However, today salary increases are at an all-time high since the study began: job hoppers are seeing a wage bump of 8%, while job keepers see wages increasing 5.9% as employers attempt to keep employees.
In lieu of salary increases in-line with inflation, many employers are turning to other alternatives. According to the Mercer survey, 41% of employers are implementing retention bonuses, which have the benefit of offering a pay bump without locking the employer into a permanent salary bump. Amy Felix Reese, the COO of leadership development company Leadership Circle, says her clients are also exploring ways to improve employee’s work experience by offering flexibility and trying to create a better working environment.
“We have to look at total compensation, of course, but people will stay for the soul and depth of an organization even if it’s not the most financially competitive,” she says.
Guadagni notes that while the short term is hard on employees who must bear the costs of inflation, employers have little incentive to raise salaries if no one else is doing it. Rather, inflation raises will become a major competitive advantage for the few who consider doing it. “The labor market is hot and lots of people are getting higher-than-normal job offers,” he said.
Tauseef Rahman, a senior partner at Mercer, urges employers to take this moment to think about how they structure their compensation. “This question points to a pre-existing lack of clarity between employers and employees about why people are paid what they are paid,” he says.
He noted that when he talks to clients, several are unable to articulate a reason behind their compensation other than falling in line with market research. “Organizations are not great at communicating pay,” he says. “This is an opportunity for greater transparency.”