The Wage Inflation Challenge: Balancing Business Sustainability and Employee Compensation

Although inflation has cooled off over the last few months, it remains a hot-button issue, especially as 74% of HR executives say inflation is a concern for their organization.   

Due to the higher cost of living, employees face escalating financial pressures, from increasing housing costs to rising grocery prices. This economic strain has led to widespread demands for higher wages. While 58% of CFOs planned pay increases of 4% to 9% this year, these decisions come with their own challenges.  

For employers, this issue extends beyond adjusting payroll numbers—it also means understanding the far-reaching effects that wage inflation can have on their workforce and overall business operations. Organizations must examine the deeper implications and find innovative solutions to balance competitive compensation with sustainable business practices.   

Understanding Wage Inflation: Beyond Basic Wage Growth   

Wage inflation refers to a sustained increase in wages that outpaces productivity growth or other key economic indicators. Unlike typical wage growth, which generally aligns with economic output and cost-of-living adjustments, wage inflation occurs when wages rise more rapidly than usual due to external pressures.   

Since 2021, wage inflation has accelerated significantly, largely due to disruptions caused by the pandemic and resulting labor shortages across various industries.   

Labor market tightness has undeniably contributed to wage increases as well. When employers face difficulties filling open positions, they often have no choice but to raise wages to attract talent.   

Elise Gould, a senior economist at the Economic Policy Institute, explained how, in recent years, labor market tightness, particularly in industries such as health care and hospitality, has put upward pressure on wages.   

“Coming out of the pandemic, employers had to work harder to attract and retain workers,” Gould said. “And so you saw wage growth, you saw some bonuses, you saw all sorts of different things happening to attract workers.”   

Factors Driving Wage Inflation   

One of the key drivers of wage inflation is inflation itself. As prices for goods and services increase, workers require higher wages to maintain their standard of living. The U.S. has recently experienced some of the highest inflation rates in over 40 years, with consumer price increases peaking at 9.1% in June 2022. Although inflation has since moderated, the higher cost of living continues to exert pressure on wages. This is particularly evident in industries that have been hardest-hit by price increases, such as food services and retail.   

Industries where wages have traditionally been lower have experienced some of the most dramatic wage increases as businesses struggle to fill positions. The service sector, for example, has seen nominal wage growth far exceed pre-pandemic averages, with wages increasing rapidly in response to the shortage of available workers.   

“Managers having to struggle with wage inflation is a sign of a healthy economy and that people’s time is worth something,” said Brendan Duke, senior director for economic policy at the Center for American Progress. “It’s inconvenient as a manager trying to think through how to manage a balance, but I think it’s a good thing that we don’t have [as many] people with master’s degrees and Ph.D.s serving coffee, which was a big problem in the early 2000s.”

The Impact of Wage Inflation on Organizations   

The effects of wage inflation are far-reaching and can significantly impact businesses’ profitability and long-term sustainability. For many organizations, rising wages lead to higher labor costs, which can reduce profit margins, particularly in labor-intensive industries. According to the Federal Reserve Bank of Cleveland, businesses in sectors such as health care, education, and hospitality have seen substantial wage increases since 2022, forcing many of them to pass these costs on to consumers in the form of higher prices. This, in turn, contributes to a cycle of inflation that affects the entire economy.   

In certain sectors, wage inflation has also led to changes in business models. The Cleveland Fed noted that companies in industries such as hospitality are increasingly adopting technology and automation to offset the rising cost of labor. Fast-casual restaurants, for example, have embraced app-based ordering systems, which allow them to maintain service levels while employing fewer workers.    

Despite these adaptations, the strain on small businesses is particularly acute. William Beach, former commissioner of the U.S. Bureau of Labor Statistics (BLS), emphasized that while large corporations have more flexibility to absorb wage increases, small businesses often struggle to maintain profitability when wages rise quickly.   

“Their input prices beyond labor have gone up dramatically because of inflation,” Beach said. “And because [small-business owners] pay themselves out of the profits of these firms, [and] because prices have gone up so much, you can look at the data, and you can see that they’ve been squeezed.”   

Strategies for Navigating Wage Inflation  

For businesses facing wage inflation, the solution lies in a multifaceted approach. Employers must find ways to balance rising wages with sustainable cost-saving measures and innovative compensation strategies to remain competitive in talent acquisition, retain employees, and keep their workforce happy.   

According to the SHRM 2023-24 State of the Workplace Report, 78% of organizations expected to pay more for talent in 2024, with 55% of those organizations planning pay increases of between 3.0% and 4.9%.  

Improving retention rates is an approach that has proven advantages. Strong employee retention helps spare employers the expensive task of competing for new talent with sky-high salaries while helping to avoid the costs associated with finding and training new workers. As noted in SHRM’s guide for HR leaders on surviving wage inflation, robust retention rates translate to better institutional knowledge, improved workplace culture, and fewer workplace disruptions.   

To combat rising labor costs, companies can leverage productivity-enhancing technologies that streamline processes and reduce the reliance on manual labor. Duke highlighted how companies can use technology to improve efficiency, especially in industries where wage inflation is particularly pronounced.   

“How you use those tools is important, and I think the hard part about automation is that it’s always less efficient to begin a new process,” he said. “But it can lead to better things at the end of the road.”   

For example, desk workers who have used AI and automation reported an overall productivity increase of 80%, according to a global survey by Slack’s Workforce Lab.   

Simple tasks such as paperwork, data entry, file and system updating, and summary and note writing are among the top ways that employees worldwide crave automation to make their day-to-day tasks more efficient.   

Offering training and upskilling opportunities is an additional strategy for organizations looking to retain talent and boost employee engagement without raising wages. Coupling productivity-enhancing technologies with enhanced training to help employees use these tools can lead to improved efficiency and higher output, benefiting both workers and employers.    

Upskilling also helps employees feel more secure and invested in their roles, as they gain new skills and see opportunities for career advancement within their organization.   

Mobile learning is one way to invest in upskilling. In a survey of organizations in India, 82% of respondents agreed that “mobile learning has enhanced employee efficiency,” while 76% “credit it for improving business results.”  

One of the most effective strategies is to offer nonwage benefits that appeal to employees without drastically increasing payroll costs. For example, Beach emphasized that investing more in women in the workforce—and providing more flexibility for working parents—should both be top priorities for employers.   

“When you’re doing your annual review of your employee benefits package, see what it might cost you to have a little bit more robust child care, and a little bit more robust leave benefits for parents, so that they can be a little bit more flexible with their schedule,” Beach said. “Parents don’t have a higher absentee rate than nonparents in firms; they actually are doing better than nonparents in terms of absenteeism.”   

These and other benefits, while not directly tied to wages, can significantly improve employee satisfaction and retention without adding to labor costs.   

Another strategy is to refresh your employee recognition program. According to a 2023 SHRM survey, feeling valued was one of the top four factors influencing employees’ experience in the workplace. Employers can get creative with recognition, offering catered lunches, gift cards, or team outings to show appreciation without significantly increasing labor costs.   

Elevating the overall employee experience is also crucial. The SHRM wage inflation guide notes that 52% of employees say they may leave their roles because they feel disconnected from their employer. By addressing issues such as outdated technology, frustrating scheduling practices, and insufficient training, employers can create a more positive work environment that may offset some of the pressure for wage increases.