Navigating Compensation Trends in Small Businesses amid Rising Inflation

Inflation continues to be a pressing issue for consumers as the cost of goods and services rise at a rapid pace. According to the Consumer Price Index, the cost of the basket of goods we typically buy has increased by about 20% since 2020. To offset this inflation tax, compensation must rise by at least as much. However, the government reports that real compensation has actually decreased by -2%, meaning prices are rising faster than our incomes.

For consumers in the bottom half of the income distribution, the impact of rising prices is even more severe. It’s not just about paying higher prices for groceries, but also about struggling to afford them at all. Small business owners have been feeling the pressure to raise compensation in order to retain and attract new workers, as labor costs are among the largest expenses for most small firms.

Recent data from the NFIB Small Business Economic Trends shows that increases in compensation have reached record high levels, with up to 51% of firms reporting raises in 2022. However, the number of firms raising selling prices to cover these increased labor costs remains high, which hinders progress on inflation reduction.

The beginning of recessions triggers a reduction in compensation raising activity, as seen in the 2008-2009 recession and the Covid shutdown. The gap between planned and actual wage increases widens as the economy expands, indicating that raises are more of a response to market pressures rather than planned initiatives.

While the percent of firms raising compensation has declined slightly in recent months, it remains at elevated levels compared to pre-2020. This ongoing pressure on labor costs is frustrating the Federal Reserve’s efforts to lower inflation, and the prospects of reaching 2% inflation anytime soon seem bleak. Inflation is expected to remain “sticky” as labor cost pressures persist, making it challenging for consumers to keep up with rising prices.