Every now and then, we’ll have Game Night with some good friends of ours.  One friend works at one of the largest companies in the US, and the other works in a small multinational firm.  Usually we’ll have an hour or so to chew the fat before dinner and occasionally, I’ll ask them how the economy looks from their perspective.

This time, I was really curious about wages, so I asked them about how salaries worked at their firms.  It’s been over a decade since I worked for a company, and I was very surprised at how wage increases were determined in corporate America.  Most economists seem fixated on a bottom-up approach to setting wages – looking at a particular job demand and supply to set the wages.

I was surprised to find a top-down process that was eerily similar at both firms.  Their departments are given at most a 3% salary increase pool.  As managers, it would be their job to allocate that 2.5-3% among their subordinates, based on performance and market conditions.  This had been the methodology for a number of years.  What really struck me was that average hourly earnings are also “coincidentally” stuck between 2.5-3.0%, and this top-down methodology pretty much ensures that we stay that way.  I’m not sure if some benefits consulting company had been making the rounds saying this was the optimal policy.  But that was a strange coincidence.

In any event, here are some other features of that methodology:

  • If they didn’t spend the full 3%, all the better! A “cost reduction” pat on the back for managers is alive and well!  But this does explain the 2.5-3.0% range at their two firms.
  • If additional funds were required, higher older earners were encouraged to retire. I suppose that’s one way to keep the wage pool lower.  I’m not sure how this affects the official AHE calculation.  I would imagine the BLS must make some kind of adjustment for seniority.  Otherwise, the huge numbers of senior higher-earning workers retiring all the time would probably cause negative wage growth.
  • When an acquisition or transfer occurred where the new entrant made a higher wage, they were told up-front that they may not get a raise for a while. I suppose this makes some sense to calibrate overall wages.  So those workers don’t count at all towards the 3% cap.
  • There are apparently a number of employees who don’t get a raise. People seem very content to work for a stable firm with full benefits.  I suppose inflation is negligible, and increasing healthcare and retirement costs can be scary.  I just got a flashback to the 20,000 people that showed up to the new Amazon warehouse to apply – mostly for the benefits.  So while wages may not be going up much, total compensation probably is.  This could also explain why consumer spending has been muted considering the tax refunds.
  • For some jobs, they literally get hundreds of applications for one opening. While these may be attractive firms to work, that’s not the sign of a tight job market.  It’s possible having more applicants are just a function of more efficient job opening information than in the past.  I’ve suspected for a while that the JOLTS data did not adjust appropriately for improved information/technology in the job search process.  But any time you have plenty of candidates per opening, you don’t have to pay as much.
  • For some technical positions, it may be hard to find employees. You hear this all the time in the Beige Book.  Even with hundreds of applications, there may only be a few with the right skill set.  But that does not mean firms are paying up to get them…
  • If a highly skilled worker was required, they first looked internally, then the marketplace. And then, they happily looked abroad to make the hire.  Whether it’s India, the Philippines, or a number of other English-speaking countries, you will generally get better candidates at a fraction of the cost.  I’m not saying this occurs for “most” jobs, I’m just saying this happens enough.

I also asked an open-ended question regarding their thoughts on other reasons for wages not increasing.  And they both thought it was because neither of their firms had much pricing power.  When you have no control of pricing, you have to maintain some cost discipline to maintain (or improve) margins.

I realize this is just a sample size of TWO.  However, it would not surprise me at all if this same process is repeated in many large companies in the US.  If you stop looking bottom-up and take a management’s top-down perspective, there’s no reason to pay workers more when you have little pricing power.  I suppose the economy could get so hot that employees are in high demand.  But who are we kidding?  The economy has been going at 2% for some time now, and this is expected to continue.  We also have many industries evaporating from technology.  This is not the kindling that going to cause wages to explode any time soon.

The main wildcard could be trade tariffs.  While that may be inflationary in the short term, that will most likely be recessionary in the long term.  Let’s see how this story plays out.