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Are Labor Costs Rising or Not?   (December 2, 2006)


Knowledgeable contributor Aaron K. sent in an excellent commentary on the huge downward revision in Q2 labor costs (from +7% down to +2%), and gently suggested I have given too much importance to labor costs as an engine of inflation:
"A few days ago, you wrote:

4. Full employment eventually raises labor costs. In case you haven't noticed, the economy is basically at full employment. Sure, many of the jobs are not great, many are low-paying, and many professionals are under-employed. But to someone who remembers the 15% unemployment of 1981, well, this is as close to full employment as reality can manage.

Actually, I don't think this is the argument to make. It is becoming more and more clear, in my opinion, that employment is only weakly connected to inflation, if at all. Stagflation was the first time this was "learned" in the modern era in this country. But it should have been learned earlier by looking at low unemployment levels in Switzerland (2-3%) and the lowest levels attained by Hong Kong (~1-2%, from back in the days before the dollar peg). 4-6% is not "low" in any absolute sense, and based on the example countries just listed, doesn't need to set off inflation. And of course, inflation can be set off anyway at much higher levels of unemployment.

Further, there is plenty of evidence that employment statistics are being manipulated to hide the true level of unemployment. John Williams at shadowstats.com has more details. When I look around me I sure as hell see a lot of unemployed and underemployed folks, and the vast bulk of IT people I know who are working doing so either directly or inderectly for the government. This doesn't at all add up to robust private sector employment in my book. The numbers are being goosed and the picture distorted.

I think we're about to see an era where a large chunk of the population is destitute in real terms, but inflation will be set off anyway, at the very least, due to government debt and bail-out spending. In other words, we're headed into stagflation again, not a growth-driven inflation, as one would expect based on the conventional analysis with the current "data". In essence, I agree with you completely (e.g., the Dow is set to fall as fundamentals don't support stock values), but simply don't consider the employment situation to be part of the case for inflation. Rather, the true employment situation is more of a case for stagnation!

I think it is pretty clear that labor costs are *lagging*, not leading inflation. One would expect the inverse to be true if employment was driving inflation.

This has been my working hypothesis for the past year, which led to me look upon the 7% number with suspicion. That view has been vindicated."
As Aaron notes, we end up on the same page: stagflation and a falling stock market. However, I remain skeptical of the labor cost data revision; it doesn't take much imagination to discern a political agenda in such huge adjustments to data--adjustments which seems to be occurring with alarming regularity (job growth and labor costs, to name just two). Both of these massive adjustments just happen to serve a political purpose: making job growth appear strong, and labor costs benign.

My own view is that the true costs paid by employers are not being captured in the statistics. Whether this is purposeful or not, the fact remains that "overhead" or "soft" costs for labor are rising faster than 2% per annum. These include the mandated benefits which employers must pay (workers compensation, temporary disability and unemployment insurance), which are usually a percentage of wages paid, and the corporate-level benefits of healthcare and pension/401K contributions.

1. Overhead costs are not trivial; they can easily amount to 100% of the worker's wage/salary. When I was a builder in Hawaii in the 1980s, to pay someone $20/hour cost us at least $35/hour--and this was with a minimal mandated healthcare plan (we paid 50%) and no vacation or retirement. First there's FICA (Social Security), then add workers comp, TDI, unemployment insurance and then toss in some healthcare and it's nearly the same as the worker's hourly wage. Worker's comp rates are very high in construction, but nowadays the medical costs paid by the employer have been rising at nearly 10% year for several years; those expenses are far larger than workers comp costs except for the construction trades. Bottom line: the non-wage expenses paid by employers have risen by leaps and bounds.

For larger companies paying full pop for premium care, the insurance for a middle-aged worker with a family can easily exceed $1,000 per month. Not many years ago that coverage was under $500; a doubling of medical costs is reality for employers, but it's simply not being reflected in labor cost stats.

Here in California, the worst excesses of our corrupt and inefficient workers compensation system were recently trimmed, but the bloat and the waste are still phenomenal. Costs were rising so fast that corporations were rebelling, and the Golden State was losing major employers faster than you could say "Cauleeforneeyah." With the threat of the golden goose leaving the bankrupt state even more bankrupt (don't ask), the legislature staved off enormous political pressure from the unions, trial lawyers, and the medical establishment and made some modest cuts to a system which was universally despised except by those draining huge bucks for bogus "care", bogus "training," bogus settlements for bogus faked injuries, etc. But the system is still a rip-off; workers get less, employers pay more.

2. 24 million employees--approximately 20% of the entire U.S. workforce--are employees of government. School boards, libraries, colleges, the Armed Forces, municipalities, counties, states--the list goes on and on. By and large, these workers receive handsome benefits and generous pensions as well as raises which generally keep up with inflation; as these costs escalate, the government raises revenue or cuts other expenses.

Just anecdotally: fully 40% of our local library's entire annual budget is devoted to the employee pension plan. This is not an isolated example by any means. That was not the case even five years ago; so when it's announced from on high that labor costs rose only 2%, I have to wonder how pension costs can be literally doubling every few years for many government agencies and health insurance costs are similarly skyrocketing, yet labor costs are supposedly unchanged.

From what I can divine, employers' total costs for labor are not being captured. If the overhead/soft costs were rising at a mere 2% clip, employers wouldn't be firing people and hiring them back as independent contractors.

The irony is that the average wage earner has no idea how much their employer pays for their healthcare coverage. Most don't understand that those skyrocketing costs are part of the reason why their paychecks haven't risen in the past five years. Believe me, the nation's employers are not paying only 2% per year more for their total labor costs, regardless of statistics--statistics which we all know are flim-flammed.

Unemployment stats--bogus. Employment stats--laughable. CPI--a complete joke. Labor costs--are these to be trusted? The last thing those in power want is for any evidence of inflation to become visible because that would call into question the politically necessary claim that inflation is non-existent.

Aaron makes a strong case that labor costs are not driving inflation, and perhaps I'm completely wrong on this. But negligible labor costs just seem too politically convenient for me to accept. Who can trust statistics when so much data is being blatantly manipulated /skewed to build a rosy picture for political expediency? On this, Aaron and I (and no doubt you, too) agree.

Thank you, Aaron, for contributing to this important subject.


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copyright © 2006 Charles Hugh Smith. All rights reserved in all media.

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