U.S. Treasury Secretary Yellen’s statement about inflation being transitory was partially correct, as shortages caused by Covid disruptions were resolved by the private sector. However, not all cost increases were easily mitigated, especially in labor costs, which are the largest expenses for small businesses. Unlike the price of oil, which can easily be adjusted when it falls, labor costs are sticky and do not decrease in response to economic changes.
During the 2007-9 economic crisis, more than 10% of employers reduced worker compensation as the unemployment rate rose to 10%. However, in today’s labor market, no owners report reducing worker compensation. Regulatory changes such as increases in the minimum wage and labor taxes also impact employment dynamics, making it difficult for less skilled workers to find legal employment opportunities.
A random sample of NFIB member firms reported reducing worker compensation at historically high rates, indicating a significant increase in labor costs. Real hourly compensation has been on the rise historically, putting pressure on selling prices. Despite efforts to restore the purchasing power of wages by cutting prices, reducing labor costs remains a challenge without a real recession on the horizon.
The path of compensation gains, adjusted for inflation, has been consistently increasing. With regulations like the minimum wage and overtime rules in place, labor costs are expected to remain high, putting further pressure on selling prices. Cutting prices to accommodate the rising compensation will require significant reductions in labor costs, which may not be achievable in the near future.
Overall, the surge in compensation and regulatory changes will continue to impact small businesses, making it challenging to adjust labor costs. Without significant changes or a recession, selling prices are likely to remain high, reflecting the ongoing pressure on labor costs in the current economic landscape.
