Is Labor Compensation on the Rise?

David Altig looks into whether recent upward revisions in unit labor costs represent another good wage signal or, as he prefers, another bad inflation signal. Okay -- ignore that one, but David does say sensible things, for the most part anyway:

Another Bad Inflation Signal?, by David Altig, Macroblog: ...But not everyone was so convinced that the rise in measured labor compensation -- specifically hourly compensation in the nonfarm business sector -- was all that meaningful. Mark Thoma highlights comments by Paul Krugman, who attempts to repudiate any claims that labor compensation is rising by perpetuating a wrong-headed focus on narrow wage and salary data.

OK -- we'll ignore that one.  But Mark, along with knzn, also commends his readers to some quite sensible observations made by Dean Baker in a post last week.  Explains knzn:

The best explanation I’ve heard comes from Dean Baker who suggests, based on the NIPA statistical discrepancy, that some capital gains (obtained, for example, via exercise of employee stock options) might be misclassified as compensation. (Conceptually, in the case of stock options, the compensation took place when the options were granted, not when they were exercised. Anything that happened to the value in the intervening time was a capital change rather than income, but the value of the options doesn’t show up on the income side of the national accounts until they are exercised.)

I'm not sure about the misclassified part.  In terms of the national income side of things, any capital gains on the options may be a wash: We essentially have a transfer from firms (that would otherwise be able to sell their stock at market prices) to workers (who get the assets at a discount).  In terms of labor costs, those transfers certainly count.

But the general point is well taken -- a jump in capital gains might well have a relatively transitory impact on labor costs, and not be indicative of a trend.  Compare (as Dr. Baker suggests in his original post) the behavior of growth in the Employment Cost Index (ECI) with that in the hourly compensation series:

There are some differences in coverage between the ECI and nonfarm business sector compensation measures -- in the treatment of government and not-for-profit workers, for example -- but they are both broad measures that cover benefit payments as well as explicit wages and salaries.  But the hourly compensation statistic - and hence unit labor cost calculations -- includes stock options. The ECI does not.   

Caroline Baum writes today...

There was certainly nothing in the narrow measure of wages in the monthly employment report to suggest a 13.3 percent annualized jump in wages and salaries in the first quarter from the fourth quarter of 2005. When Commerce's Bureau of Economic Analysis reported the revised figures last week, the lumping of the income gains in the first quarter suggested to many economists that the source was bonuses and options.

and Asha Bangalore seconds:

The most noteworthy part of the report was the significant upward revision of hourly compensation to a 13.7% gain in the first quarter from the previous estimates of a 6.9% increase. This is a reflection of compensation increases coming from stock options and bonuses which are reflected in the income side estimates of GDP. This is a one-off event and not a reflection of a big change in the underlying trend of labor costs.

That, and the stable-to-declining pattern of compensation in the ECI, should give us pause about concluding we are at the beginning of any lasting acceleration in the return to labor.

Comments

[lonesome moderate]

Are the costs of health insurance coverage that employees receive as a benefit used in computing the CPI? If they are not, perhaps they should be.

[anne]

What is it about these folks that the bond market does not exist or there is a reason to ignore the bond market when you wish to contradict it. With a long term Treasury at 4.79% and stable, if labor costs are an issue then institutional bond investors have not found it so. Labor costs however have not been an issue through the Federal Reserve tightening sequence and are not an issue now though we would be better serve if there had been stronger wage and benefit increases. Worry about a weakening of the economy, not rising labor costs.

[anne]

Labor costs, wages, are not a problem:

http://www.epi.org/content.cfm/webfeatures_snapshots_20060906

September 6, 2006.

The Gender Pay Gap is the Smallest on Record—Not Necessarily Good News
By Sylvia Allegretto

New data released by the U.S. Census Bureau show that the gender pay gap for full-time, full-year workers is the smallest on record. The shrinking gap was a feature in the Department of Labor's report, Highlights of America's Workforce: Labor Day 2006. Women now earn 77 cents on the dollar compared to men. After an increase in the gap from 2002 to 2003, the gap shrunk over the last two years. However...these declines were solely due to the fact that earnings have fallen for both men and women, but have fallen more so for men—not a desirable scenario.

Amazingly, the Department of Labor brags that the gender gap in pay is now the smallest ever, while completely ignoring how we got there. Following current earnings trends, ... projects what more "good news" of this sort would bring in the decades ahead. It turns out the gender gap would completely close in 2024, when earnings for full-time, full-year workers would be just under $25,000—40% below today's level for men and 22% for women.

Of course this projection is preposterous, but it clearly shows the absurdity of celebrating that men's pay is shrinking faster than women's.

[anne]

The problem for the Federal Reserve from here is being increasingly anxious about and protecting against recession. This is not a traditional turning point in Fed policy because of the possibility of a sustained fall in housing activity and prices.

[reason]

Anne,
I'm not so sure that projection is so preposterous, particularly not in real after tax terms. Make no mistake the US is likely to have to increase taxes and to suffer a large terms of trade correction.
Of course good micro policy could lead to better distribution to offset these effects.

[anne]

There will be no tax increase, especially not now with the economy fragile, but not after as long as we have such a political mix as present. Also, the last thing Democrats need is to be blamed for a tax increase which they would be were they in a position to push for one. No; not going to happen. But, I am not a deficit monger and I remember what happened to a certain California governor when he allowed taxes to rise. "Hasta la vista."

[anne]

Should there be a problem with inflation, which I do not expect, the Fed is in control. The question is, can the Fed keep us growing reasonably to allow for decent wage and benefit increases?

[reason]

anne,
there will be a tax increase of some sort - it is just a question of when and how. It may happen via bracket creep and inflation but it will happen. We have seen how spending can't be trimmed below 20% and how there is currently a structural budget deficit. Total indebtedness is not in the danger area yet, but sometime it will be. Hyperinflation is not pretty. Before that happens there will be tax rises.

[spencer]

Anne--
Use to be if your forecast of unit labor cost was good your forecast of inflation would also be good. But for years the tight fit between inflation and unit labor cost has broken down. The bond market knows that and that is probably why it did not react to this report.

But a stable bond market is a shift -- it had been in a significant rally as it retraced much of its spring yield increase. It is starting to look like the bond yield has bottomed -- at around its 12 month moving average-- and the next move will up, not down as
evidence emerges that the economy and inflation are not
as weak as many thought.

[Stormy]

Give us "pause"? I suggest that those here check on what "caps" are being put on benefits...say, by the likes of Verizon and other large firms. Well, the benefits are not capped for some, backdating stock options.

Do economists ever check the pulse of real corporations?

[Stormy]

Ok...because no one will reply...and before all this is buried with another topic...

Check out what Verizon has in store for future retirees:

"Effective July 1, 2006, 50,000 management employees will no longer earn pension credits or service toward the company's subsidy of retiree medical benefits. It is important to note that employees will keep any pension benefits they have already earned."

http://www.vzmultimedia.com/responsibility/empower/development.aspx

Now, Verizon tries to lighten this up a bit with modifications of the 401K, but this is, nonetheless, a kick in the groin to long-term employees.

Verizon is not alone is this move.

In short, in the future, we are going to see white collar retirees increasingly on their own, despite company loyalty and service.

Important to note here: This change affects management, those kind folks just below the top echelons. Hmmm...maybe universities should start making this kind of change.

Economists haven't a clue as to what is happening in the real world.

[anne]

Spencer:

"But for years the tight fit between inflation and unit labor cost has broken down. The bond market knows that and that is probably why it did not react to this report."

Agreed; and by referring to a stable bond market I was thinking of the absence of volatility, for long term interest rates have fallen through a moderate range. I would also prefer as would the Fed that the economy be stronger than we suppose.

Reason:

Possibly, even probably, tax rates will rise several years from now, but surely not these coming 2 years. I am however not the least worried about hyperinflation, for that is what the Fed alone will prevent no matter deficits. I am just not deficit fretting.

[Robert]

Anne said:

What is it about these folks that the bond market does not exist or there is a reason to ignore the bond market when you wish to contradict it. With a long term Treasury at 4.79% and stable, if labor costs are an issue then institutional bond investors have not found it so.

I admire you faith and confidence in the bond market as prognosticator & oracle extraordinaire. But I can't help wondering whether the accumulation of Treasury Bonds by Asian Central Banks, the sheer quanitity "policy investors" that buy Treasuries whether they are yielding 3% or 6%, coupled with the Treasury's disingenious idea that borrowing short and limiting the supply of long bonds will help artifically reduce yields the cost of financing outstanding debt, have together conspired to diminish the accuracy of the previously-omniscient bond-market. Add to this the global phenomena amongst pension funds where they are short of duration across their portfolios, and thus might still be "bid" for bonds solely to increase duration, even though this might be contrary to their, or their consultants views on yields.

[johnchx]

lonesome moderate wrote:Are the costs of health insurance coverage that employees receive as a benefit used in computing the CPI?

The basic answer is "no." It's actually a little more complicated than that -- the CPI *does* include a component for medical insurance, but it's (a) measured indirectly and (b) not weighted to reflect employer-paid health insurance (so the weight that health insurance inflation has in the overall CPI reflects only individual-paid insurance premia).

A discussion of this can be found at the BLS website, here (towards the bottom of the page).

There's pretty general recognition that this is an area that needs improvement, and I believe that there's a research project underway at BLS to address the issue.

[Dave Altig]

Mark -- I never really understood Brad's argument on my earlier post. He seemed to be saying that an inferior measure of labor compensation is better than none, but that is a false dilemma. Unless you absolutely insist on monthly data, ECI and hourly compensation are readily available -- so why stick with a statistic that we know is flawed? Brad's response seemed to be that he cares about the wage at the median, and nonwage compensation doesn't matter much there. OK, but that is then a question about the distribution of returns to labor, not the aggregate return, which is what I was talking about. I have conceded in earlier posts that there are questions for which the narrow average and median wage measures are appropriate. But the current converstion about labor costs and potential inflationary consequences isn't one of them.

By the way, I was trying to argue that the latest unit labor cost stat is not comfortably interpreted as a bad inflation signal or a good wage signal. I think we're agreed on that. Cheers -- dave

[anne]

http://norris.blogs.nytimes.com/?p=27

September 7, 2006

Inflation Sign? Don't Bet on It.
By Floyd Norris

There was much concern on Wednesday over a report showing that unit labor costs surged in the first quarter.

But there should not have been. It was not wages that were going up. It was the stock market.

Robert Barbera, the chief economist of ITG, points out that the driving force in that change was a revision in the figure for growth in wage and salary income. And while you may think wage and salary income is just that — the money you get directly from your employer — the government also includes the profits people make from cashing in stock options.

"It almost certainly was a consequence of an explosive exercise of options," Mr. Barbera said.

When the government first estimated the first quarter figure for growth in wage and salary income, it came up with an annual rate of 7 percent. That was reasonable based on the data it had, which come from the monthly employment numbers. But since then it has gotten real data, which led to the increase.

The stock market struggled late last year, and then rose nicely early this year. What this almost certainly means is that a lot of people cashed in their stock options. That is good for them, but it is not a sign of inflation.

Mr. Barbera says he expects that the pace of options exercises slowed down in the second quarter, and that the annual rate of growth in wage and salary income for that quarter will be cut back from the first estimate of more than 7 percent to just 1 or 2 percent. If so, in three months we'll hear that unit labor costs have settled down.

He points to the first quarter of 2000, when wage and salary income grew at a rate of 15 percent, but then fell to 2 percent in the second quarter. Then, as now, it was the options.

The problem with this number is not that it is wrong; it is that the Federal Reserve may pay attention to it and think that it needs to tighten again. The economy is slowing, and higher rates are not what it needs.

[anne]

Robert:

I understand the qualms, but the mere lack of volatility, or what I have termed stability because of the extended calmness, of the long term bond market tells me not to worry about inflation. Labor costs are not a worry, though I would be happier if they were at least a little worry. Another indicator I prefer is the real estate investment trust index which has been and stays remarkably robust. REIT investors are not worried about long term interest rates.

[Robert]

Anne said: "REIT investors are not worried about long term interest rates."

I am not so presumptuous to believe that I know what precisely is driving REIT investors, and what they are worried about. But I would take a wild guess that many are afraid of inflation concommittant to a bond market that, for all intents, has been neutered. THAT is the scenario that makes a pension fund trustee lay away at night wondering how her "safe" bond portfolio will ever deliver returns required to meet future actuarial obligations. Commercial Real Estate is simply a lesser evil - a bond imbued with high-yield volatility and an inflation hedge that bears closer relation to something akin to the market supply of dollars, rather than BLS's more dubious measure(s). Historically, as UK pension funds & life co's know (and it should be noted that they are experts in hedging the more or less continuous debasement of GBP Sterling) real estate has far outperformed gilts or other fixed interest secs over the long term. US investors - in the waning years of dollar hegemony - are finally taking note.

That reality is a long way from saying REIT investors are not worried about long rates. Near zero or negative real rates will continue to be a boon for asset holders and an eventual curse to bondholders - whether they know it or not yet. The hunt for duration, and concern about inflation and authorities willingness tackle it is leading pension funds & life co's to real estate for long tail liabilities. And this is before one even mentions Petrodollars. This is of course the Feds conundrum: any slacking will continue to whip up asset prices; too much will drive real yields to a level that systemic leverage cannot countenance.

This doesn't make recent REIT price appreciation a lay-up or correct. Stagflation will see a race between declining yields from asset investors (and perhaps falling bond yields) on one hand and rising vacancy rates on the other, due to the same softness. A few extra years (as we saw from '02 to '05) could validate their investments. However, I think eventually (and prolly sooner than later), PK/DeLong/Roubini's dark forces of revulsion will win causing a drop in capital values. If one buys this, it implies that the forces driving REIT prices in the short-term may be driving them in a direction that is divergant from medium-term equilibrium. And that the bond market is a useless guide [at present] to gauging systemic risk.

While the inflation fears may be overblown, its worth noting that Colony Capital and some other of the more savvy real estate investors who've seen a number of cycles are notably on the sidelines, and this latest rush (Morgan Stanley's latest high-profile REIT take-overs) are perhaps dominated by policy investors who, after several years of trustee meetings, consultant reports, hand wringing, and beauty contests with managers have finally approved and now funded their probably ill-timed allocations. Ding!! DIng!!

[ino rossi]

is this a discussion forum> wo runs it? what is the base web page address for quoting?