Middle Market Average Salary and Unemployment: A Complex Interrelationship

The National Center for the Middle Market has already offered analysis on the potential impact on middle market companies of a proposed increase in the federal minimum wage. As NCMM articles have made clear, there's also a trend among the U.S. states to raise their respective minimum wages, with 21 states so far mandating a minimum wage above the current federal level of $7.25.

 

Many factors contribute to salary/wage trends

  

Navigating the Wage Curve

A larger and more relevant question for middle market companies is the relationship between average salary/wages with changing rates of unemployment. Economists describe this relationship as a wage curve, and it shows that, as competition increases for labor (i.e., as the unemployment rate lowers), the average salary/wages for workers will generally increase. Conversely, as more people are unemployed, wages will drop. Obviously, the wage curve depends on several factors, such as overall employment in a particular area and the supply of particular skills that companies may need. Even in a geographical area of high unemployment, companies may not be able to find workers with the particular skills required. In this skills shortage scenario, companies may need to pay higher wages to gain workers with hard-to-find skills.

The classic wage curve, however, isn't as simple as it might first appear. It assumes that, in periods of recession, average salary/wages should drop at a rate consistent with increases in unemployment. But as every manager knows, pushing down on average pay within your organization isn't so easy, since it has direct impacts on staff morale and indirect impacts on productivity. As a report from the Federal Reserve Bank of San Francisco puts it, "Many employers would have preferred to cut wages [during the recent Great Recession] but couldn't do so because of the reluctance of workers to accept reduced compensation." Even though unemployment increased by nearly six percent during the recent recession (reaching a high of nearly 11 percent), wages, rather than drop by six percent, more or less remained the same. This pattern contradicts the classic wage curve.

Fighting Wage Rigidity

According to the same Federal Reserve Bank of San Francisco report, there are pent-up average salary/wage cuts that continue to impact companies, even as firms recover and start growing again. If unemployment eventually drops back to prerecession levels and companies start to hire more workers, it's still likely that wages will not grow to reflect any decreases in unemployment. This wage rigidity will be with the economy for a while, and this is exactly why President Obama is seeking to force wages in an upward direction through a federal minimum wage hike and other initiatives. The president believes that a growth in wages will increase consumer buying power and thus stimulate the overall demand for goods and services. The downside, of course, is that these initiatives will push up labor costs for middle market companies at a time when the U.S. economy is beginning to recover from a long recession.

Preparing for an Uncertain Future

The takeaway here is that, if the market for labor is left to its own devices, wage rigidity caused by pent-up wage cuts will likely keep wage growth relatively low in the near future. How long this rigidity will last largely depends on the speed of the recovery. Accelerated growth in the U.S. economy would certainly lead to a general increase in wages, despite the pent-up cuts. Moreover, changes in government policies at both the federal and state level that are designed to push up wages could also lead to accelerated wage growth for middle market companies.

All of these interrelated factors of macroeconomic growth, changes in governmental policies, and the complex economic relationship between wages and rates of unemployment are critical and bear watching. There aren't any simple, clear-cut answers ahead, but it's worth monitoring these factors closely to help prepare your middle market business for whatever changes are coming.

What single factor should midsize firms pay the most attention to? Let us know what you think by commenting below.

Boston-based Chuck Leddy is an NCMM contributor and a freelance reporter who contributes regularly to The Boston Globe and Harvard Gazette. He also trains Fortune 500 executives in business-communication skills as an instructor for EF Education. Circle him on Google+.