In the decade since the 2008 recession we’ve had an enormous runup in the stock market, accelerating growth in GDP, and a steady increase in job growth. Yet despite these positive economic trends, wages are not keeping up.
Yes, they ticked up in the most recent jobs report, but they're still lagging in a significant way.
In this article, I’d like to explain why this may not a problem of economics, but rather an issue of management – and one which we can address by changing the nature of the discussion.
Point 1: Wages Are Not Keeping up.
Let’s just discuss the issues of wages: they are not keeping up with inflation. Consider the data below. While the GDP has risen (after inflation), real incomes have barely budged.
In fact, if we look at U.S. wages over the longer term, wages after inflation have barely budged over the last 44 years.
It’s frightening to consider, but my parents, who were a young couple in the 1960s, could buy a house for less than 25% of their take-home pay. They owned two cars and put my brother and me through college on a middle-income salary. (My father was a scientist with a mid-level job.) That dream is elusive today.
As Heather Boushey, an economist with The Washington Center for Equitable Growth puts it,
The economy is growing. Why aren’t people feeling it?” Boushey says. “The answer is: Because they literally aren’t feeling it.
And it seems to be getting worse. Despite an increase in wages most recently (2.9% as of August of 2018), income inequality has increased, leading even more to feel they aren't keeping up. While the stock market has benefited those with savings and 401(k)s, most don’t feel it.
Point 2: Workers Are Struggling
The second piece of evidence I want to point out is the level of financial stress we see among workers. Look at some of these statistics:
- 40% of Americans had trouble paying for food, medical care, housing, or utilities in the last year.
- Nearly half of Americans have no retirement savings, creating increases in stress-related illnesses and heart disease
- 63% of Americans do not have $500 of cash on hand to handle emergencies or other significant expenses
- 70% of college grads have $15,000 or more of loans outstanding in their first year of work
- 4 in 10 Americans now have a “sides hustle” to make more money to help make ends meet[9]
- Employers like Wal-Mart, McDonald’s, Ubers, and Outback Steakhouse are now building programs to pay people every day, so they can better manage their cash.
In my industry, the domain of Human Resources, the demand for “real-time payroll” is so high that companies like ADP and SAP are rewriting their payroll software. This is one of the most massive re-engineering projects in HR software I have seen in 20 years.
I live in the San Francisco Bay Area, and although wages are rising, almost everyone I talk with tells me they feel like they are falling behind. Housing prices in many cities are skyrocketing, the cost of transportation continues to rise, and the Deloitte Global Millennial survey shows that 45% of Millennials now believe they will never achieve the financial status of their parents. Unbelievably, almost 40% of them are doing side-hustles to make more money.
Point 3: Companies Are Sitting On Cash But Not Raising Wages
HR and business leaders are well aware of these financial issues, yet are afraid to raise wages.
Apple, for example, recently announced that its quarterly revenue grew to $61 billion (making it a $250 billion company) and that it generated $13.8 billion in profit (almost 23% profit). This means that for every dollar you spend on an Apple product or service, 23 cents goes to the bank.
What is Apple doing with this money? They’re returning it to the shareholders. The company announced it will distribute $210 billion to shareholders through stock buy-backs and will increase its dividend as well. If you own Apple stock, you see a good return, but if you’re an Apple employee, you may or may not see a thing. (P.S. Apple pays only a 14.5% tax rate.)
Apple, by the way, has about 80,000 employees, so if the average employee makes $100,000 per year (which is high), Apple could give them all a 5% raise, and it would only cost the company $400 million per year, which is less than 0.2% of the cash the company is using for stock buybacks.
In other words, Apple management believes it is better for the company to return cash to the shareholders (which enriches its stock price) than it is to invest in the salaries of its employees.
I’m not saying Apple is underpaying its people. Apple employees are well paid (software engineers make well over $100,000) and sales and service representatives are fairly paid. The point is to consider how management is thinking: at a time when the company is flooded with profit, management chose to invest in its share price. Companies do not see employees as an investment.
(A recent article in Business Insider shows that companies repurchased $4.4 trillion since the 2008 recession, $191 billion in this last quarter alone). This is money just being returned to the shareholders – why isn’t it being invested in employees?
Why are companies afraid to raise wages? Economists often point to the “Sticky Wages” effect.
As economists teach in school, management hates to raise wages because once you raise them, it’s hard to take them back down. And in the inevitable time of a recession or slowdown, you’re stuck with a high cost of labor.
Managers are acting this way now. A recent article in the Wall Street Journal points out how bonuses and benefits are going up, but wages are relatively flat. Companies are willing to pay as much as $25,000 bonus to diesel electricians and train crew members, but they don’t want to raise base pay. (Even Amazon’s announcement to raise wages to $15 per hour was coupled with a reduction in stock rewards.)
Point 4. The Sticky Wage Theory Has Flaws
I’ve been talking with economists about this issue, and the “sticky wage” theory is firmly embedded in peoples’ minds. In this theoretical construct, wages are slow to rise because they’re even slower to fall. So managers hold onto cash and delay salary increases because they know how hard it will be to cut them later.
But my research shows this philosophy has flaws, especially in a skills-driven economy like we have today.
Suppose a company like Google, Facebook, Amazon, Goldman, or another “trillion dollar cap” digital disruptor decides to pay people more. They bid up the price of labor and pay people high wages to attract the very best.
(Amazon, for example, gives all its employees stock options, which are often worth tens to hundreds of thousands of dollars in only a few years.)
These high performing companies just ignore the sticky wage theory and act like winning sports teams, bidding high prices for the super performers. Do they create wage inflation and make inequality worse? Not necessarily.
When a company raises the wages of all its workers, including the frontline service workers, something entirely different happens. Employees feel more committed; their financial lives become less stressful; they are proud to be part of the company; their attitude and service to customers and client get better. In fact, the company’s employment brand becomes more positive, so every position now attracts more committed, passionate, ambitious people – and ultimately the company performs better.
Zeynep Ton, in the heavily researched book The Good Jobs Strategy, clearly points this out as she compared wages between Costco, Mercadona, Tesco, and Wal-Mart. Her research showed that higher wages in retail result in a more profitable operation. The reason? Well paid employees are better trained, they are more engaged, and they spend more time helping customers buy the right products. In one of the studies, they found that a $1.00 increase in hourly wages resulted in a 40% increase in total profits, a hugely positive return on investment.
What about the problem of a business downturn? The sticky wage theory would say that you have less flexibility to reduce cost.
Well, in fact, the opposite is true. If managers are underpaying people now, the option of “reducing pay” is limited, so when the business turns down managers have to lay people off. While layoffs are common, they almost always result in a negative outcome. Not only does the company’s employment brand suffer, but the “survivor syndrome” of those who remain dramatically reduces their loyalty and engagement.
Extensive studies done by Wayne Casio at the University of Denver and academics at MIT and Wharton prove that companies that lay people off then later underperform for years. I distinctly remember how Circuit City tried to “layoff its way to profitability” and eventually went out of business. American Express and other great brand have seen this problem when they lay people off, so it’s not just an indication of a company with a poor product or out of sync offering. Layoffs are permanently damaging.
On the other hand, if you pay people well from the start and they feel a genuine commitment to the company, they will do anything to help manage a downturn. Southwest Airlines did not lay people off during the 2008 recession, and they continue to thrive. Steve Jobs famously reinvested in innovation during the 2000 recession and gave birth to the iPad.
When people are well paid you have enormous flexibility to ask people to take a temporary pay cut, and they will stick around and work even harder. (Intel, a company that has been through many business cycles, is famous for investing during recessions because it’s a time to attract some of the brightest and most sought-after people.)
Point 5: This Is A Management Issue, Not an Economic Issue
The bottom line is this: lagging wages in the U.S. is not an economic issue, it’s really about management. The spirit is there, but the actions are not.
Just as Marc Benioff, CEO of Salesforce believes “inclusive capitalism” is his mission, and Jeff Bezos is funding a $2 billion fund to help homelessness, and many other CEOs are trying to take on social causes, they are reluctant to act with their paychecks. And this old way of thinking is holding the economy back.
Let me make another important point. In business school we are taught that labor is an expense to be managed. CFOs look at the cost of payroll (which is often 40 or 50% of revenue) as one of the biggest discretionary expenses on the income statement.
But in reality people aren't an expense, they are an investment. As I like to point out in my talks, people are an appreciating asset: the more we invest in them, the more we see productivity, customer service, innovation, and growth. And in today's labor market, raising wages lets employers attract the most ambitious people, something every company is striving for now.
I think we have to rethink our accounting practices too: consider labor an investment like machinery. But one that goes up in value, not down.
Also, Pay Practices Are Out Of Date
As I've looked into this issue, one of the problems we found is that pay practices are out of date.
We recently did a large study of pay practices and found that only 7% of companies believe their pay system is aligned with their corporate goals and 30% told us it was misaligned.
Why? The way we pay people is based on legacy models. We only review wages annually; we are afraid to overpay high performers; we are afraid to explain to people why they are paid what they are.
When we asked employees and HR people to rate their pay practices, we found a net promoter score of -15, the lowest of any HR practice we have studied.
Why is it so hard to fix pay practices? Not only are CFOs holding companies back, but the HR department is partly in the way. Companies are concerned about pay equality, salary bands, carefully staying within benchmarks, and not providing a holistic view of pay. People want to be paid more frequently, they want a wider range of benefits, and they want programs that meet their particular needs, not just lists of programs they never plan to use.
The pressure to fix pay is building. Research from TIAA Institute found that 40% of U.S. adults rate C, D, or F in financial literacy; 1/3 of Americans pay their minimum credit card balance and the average credit card debt is $5,839, and the median retirement balance is only $3,000 (50% of American households have no saving). In other words, there’s plenty of pain out there, and if employers fill these gaps they gain tremendous engagement from their people.
If you want to put a simple ROI on better pay, consider the impact of poor financial wellbeing. The same TIAA research I cited earlier shows that 64% of millennials feel financially stressed (15% of their salaries goes toward student loans), 32% say it impacts their daily work, and 33 peer-reviewed studies proved that financial stress leads to heart attacks.
A Call To Business Leaders and Management
I talk with HR managers, employees, and young professionals every day. Despite the job numbers they are not happy with their pay and they are scrambling around to keep up. The problem isn’t the mystical “economy,” it’s simply the way CEOs and managers think.
Imagine if the top companies who purchased back stock int least ten years (Apple, $102 billion; Microsoft: $878 billion; Cisco: $228 billion; Oracle: $67 billion; JPM Chase, $63 billion; Wells Fargo, $56 billion; Intel: $55 billion; Home Depot: $51 billion) took a tiny percent of this money and raised the wages of their lower-wage customer-facing employees. Would the company feel it? I believe not – and their performance as a business would rise.
What I believe is going on is a new paradigm of management, one where CEOs and CFOs must understand that every employee provides an outsized value to the company. And if we consider them as an asset and not an expense, we find that the return on higher pay is greater than we thought.
If you don't want to raise wages, I'd ask another simple question. Given the highly competitive nature of the job market, what will you do? Well-being programs and other benefits are growing, but they aren't enough.
Let's not just blame the "economy" for income inequality and slowly rising wages. I'd encourage you to think about your business differently, and remember that in today's service-driven economy, people are the product. Invest more in people, and profits will follow.
