In a recent statement, U.S. Treasury Secretary Yellen mentioned that inflation was transitory, but she may have misunderstood how cost pressures are transmitted and mitigated in the economy. While shortages caused by disruptions in transportation and production due to Covid were resolved by the private sector, not all cost increases were easily mitigated. The production of goods such as cars increased, leading to lower prices, but the same could not be said for labor costs, which are the largest operating costs for small businesses.
During the economic crisis of 2007-2009, the unemployment rate rose to 10% and more than 10% of employers reduced actual compensation for their workers. However, in the current labor market, 0% of owners report reducing worker compensation. Regulatory changes, such as an increase in the minimum wage and labor taxes, also impact the employment dynamic. These regulations may prevent less skilled workers from gaining work experience and developing skills.
Data from a random sample of NFIB member firms shows that labor costs have increased at historically record high rates. Real hourly compensation has also been on the rise historically, as illustrated in Chart 3. The recent surge in compensation, along with regulations like minimum wage and overtime rules, will continue to put pressure on selling prices. Cutting prices to restore the purchasing power of wages would require reductions in labor costs, which may be difficult to achieve in the next few years without a real recession.
Chart 1 demonstrates how employment costs are adjusted under extreme economic conditions, with the unemployment rate reaching 10% during the 2007-2009 period. In contrast, there has been no reported reduction in worker compensation in the current labor market. The percent of small business owners reporting reductions in worker compensation has also been on the rise.
Overall, the increase in compensation and regulatory changes will continue to keep pressure on selling prices. Cutting prices to accommodate these changes will require reductions in labor costs, which may not be easily achievable in the near future. The data suggests that labor costs are a significant factor for small businesses, and any changes in compensation or regulations will have a direct impact on their operations and pricing strategies.
