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Wages Stall as Companies Spend Generously to Recruit, Not Retain

Sharply higher wages for new hires create risk of pay compression

December 2, 2019 | Stephen Miller, CEBS

Two businessmen shaking hands at a desk.

For the past several years, U.S. companies' salary increase budgets have held steady, increasing around 3 percent. While economists argue about the reasons for weak wage growth, an analysis from The Conference Board may provide part of the answer: Businesses are willing to spend more to hire new talent than to reward and retain current employees.

In the aftermath of the Great Recession of 2008-09, U.S. companies have largely refrained from raising their salary increase budgets, which show annual growth well below prerecession rates, according to The Conference Board's long-running Salary Increase Budget Survey. The survey polls compensation executives about their salary plans for the year ahead.

Yet in recent years, amid a tight labor market, companies have committed substantial sums to recruiting new hires. As a result, wages for younger workers, who approximate new hires, have risen sharply. U.S. workers ages 20 to 24 saw their pay increase by over 5 percent this year, while workers overall saw wage growth of around 3 percent, the survey showed.

Wages for Younger Workers—a Proxy for New Hires—Have Risen Sharply

The chart below shows the annualized percentage change in wages for workers ages 20 to 24 versus age 16 and over, from the fourth quarter of 1985 through the second quarter of 2019.

Source: U.S. Bureau of Labor Statistics and The Conference Board.

The survey was conducted between April 16 and June 21, with responses from 229 organizations.

"Weak inflation and low cost-of-living adjustments are partly contributing to stagnant salary increase budgets, which explains why existing workers, as opposed to new hires, haven't seen their wallets thicken to the extent many expected," said Gad Levanon, head of the Labor Market Institute at The Conference Board, a business membership and research association.

However, a short-term focus on minimizing labor costs could backfire. If wage structures aren't adjusted to reflect higher pay for new hires, employers are likely to see higher turnover as existing workers discover that younger and less experienced colleagues earn as much as they do, or more.

"Replacing an employee is often more expensive than retaining that employee with a pay increase," Levanon noted.

Reducing turnover in this environment might be achieved by raising wage levels or increasing other types of compensation, such as variable pay, merit bonuses and nonmonetary awards, he advised.

Money Talks When Hiring Generation Z

Most Generation Z workers and workers-to-be say salary is the most important consideration for their first job, according to an April 2019 global poll of 3,400 respondents ages 16 to 25. The survey, conducted on behalf of The Workforce Institute at Kronos Inc., a workforce management software firm, revealed that:

A majority (54 percent) of Generation Z respondents worldwide—including 59 percent in the U.S. and 62 percent in the U.K.—said pay is the top factor they consider when applying for their first full-time position.

Money becomes increasingly important among older members of Generation Z, with 57 percent of 22- to 25-year-olds agreeing that nothing outweighs pay, compared with 49 percent of those ages 21 and under.

[SHRM members-only how-to guide: How to Establish Salary Ranges]

Pay Compression Risks

The imbalance between spending on new hires and existing workers already has resulted in historic pay compression, The Conference Board found, with the gap between the wages of 20- to 24-year-olds and 25- to 34-year-olds having shrunk to its smallest size in 36 years.

The gap between the wages of 20- to 24-year-olds and 25- to 34-year-olds has shrunk to its smallest size in 36 years.

To lessen the risk of pay compression and its consequences, "employers should consider a more rapid adjustment to their pay structure to limit the damage," said Frank Steemers, associate economist at The Conference Board and co-author of the report.

"With various pay transparency tools and websites at their disposal, existing workers have greater insight these days into what their colleagues who just came on board are earning," Steemers said. "If current workers perceive the salaries of new entrants as unreasonable compared to their own, companies can either brace for higher turnover or take steps to retain them, including raising their compensation."

Slowing Inflation Could Bring Higher Real-Wage Increases

With U.S. companies expected to give 2020 pay increases that average 3 percent of pay, and an expected 1.6 percent U.S. inflation rate, next year's inflation-adjusted "real wage" increase is forecast to be 1.4 percent for workers in the U.S., up from last year's 0.6 percent inflation-adjusted increase, according to a multinational analysis by pay consultancy Korn Ferry.

The findings are based on data from the firm's global and U.S. pay databases and 2020 country-specific inflation forecasts by the Economist Intelligence Unit, which provides business analysis and advisory services.

According to the U.S. Bureau of Labor Statistics, as of July 2019 the consumer price index for U.S. urban consumers (CPI-U) was up 2.2 percent over the preceding 12 months. As of July 2018, the CPI-U was up 2.4 percent over the preceding year.

Some forecasters project the U.S. inflation rate for 2020 won't fall as steeply as others predict. For instance, the Federal Reserve Board expects U.S. core consumer prices will increase 1.9 percent in 2020.

"While inflation indices are a solid benchmark for reviewing market trends in pay, we recommend that companies take a broader perspective by defining and agreeing upon their own measures of cost drivers, business strategy, and local ... conditions," said Benjamin Frost, Korn Ferry global general manager for pay. "Compensation programs need to be regularly reviewed to make sure they align with changing business and market conditions."

Related SHRM Articles:

2020 Salary Budget Growth Expected to Notch Just Above 3%, SHRM Online, July 2019

Address Pay Compression or Risk Employee Flight, SHRM Online, June 2018

Salary Increase Projections 2020 (and 2019), SHRM Express Requests