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How Inflation Affects Employee Compensation


Employee Management

How Inflation Affects Employee Compensation

Inflation affects employee compensation by reducing the purchasing power of their salary over time. Employers must consider the impact of inflation when setting salaries, negotiating wage increases, and offering benefits packages to remain competitive and attract top talent.

February 1, 2023
min read
February 1, 2023
8 min read
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The aftermath of COVID, plus other factors, has severely increased inflation rates. Most countries saw record-high prices of fuel and other consumables. And even though inflation has started slowing down, these prices will remain high for some time.

While people are more focused on how inflation affects the cost of living, business owners are more concerned with the effect high inflation has on employment. The cost of living is up, meaning employees’ salaries do not adequately serve their needs as they used to.

So what happens? Are employees taking up second jobs? Have companies increased salaries and employee benefits? And if not, should they? The information below provides insight into these and related questions.

Effects of Inflation on Employment

Surprisingly, inflation does not immediately lead to unemployment. In the short term, inflation can lead to lower unemployment rates.

When inflation increases, it decreases purchasing power, thus discouraging saving. Therefore, more businesses invest, and consumers spend. As a result, companies will hire more employees to keep up with the supply chain.

In addition, people are more likely to come out of retirement or vacations to keep up with inflation. Therefore, the unemployment rate significantly decreases during the initial stages of inflation.

Economist A. W. Philips explained the relationship between unemployment and inflation through what is now known as the Phillips curve in 1958. Unfortunately, as the curve proves, low employment rates can only last for so long.

As employees become fully aware of their loss of purchasing power, they are less willing to settle for low wages. Since many businesses suffer the effects of inflation, layoffs become more common. Thus unemployment rates increase, returning to their natural state even as general inflation continues to soar.

The short-term effects of inflation only seem positive since unemployment rates decrease. But long-term inflation brings unemployment rates back to their natural state, proving that inflation cannot benefit the economy through higher employment rates.

Now, a little insight into inflation and compensation.

How Does Inflation Affect Employee Compensation?

One of the biggest concerns about inflation is how it will affect employee compensation. Employers and employees need to understand these effects for appropriate navigation into a satisfactory annual salary and good retention rates.

The direct impact of inflation on employee compensation is increasing budgets to gain purchasing power, thus reducing savings.

Employees with a higher cost of living are forced to increase their salary budgets to purchase goods and services. So let's say, for instance, that an employee earned a monthly salary of 20,000 after taxes with monthly expenses of 15,000. The employee would have 5,000 saved up every month.

So what happens in 2023, where goods and services have reached record-high prices, but the salary remains the same? The employee will have to save less (or nothing at all) per month to make ends meet.

Therefore, it is safe to say that inflation decreases the value of employee wages. Thus, employees are forced to develop alternative outlooks on earning money.

Some employees take up supporting jobs to earn more money. Depending on the job's demands, it can lead to a significant decrease in productivity as the employee splits their time and effort between two positions.

Some employees leave their positions searching for better-paying jobs. This, unfortunately, reflects poorly on the businesses, especially if many employees leave the company.

Alternatively, some employees choose to stay but demand better compensation to keep up with inflation demands. Some employees agree to it to keep retention rates while attracting talent to the company.

However, pay increase is never at pace with inflation for two main reasons:

●  Increase in production costs

The salary increase will drive up production costs. Therefore, businesses must pass on the additional costs to consumers to retain profits.

●  Salaries take time to change

Businesses are cautious about increasing or decreasing wages. Owners must determine how pay raises will affect the company in the long run. 

How does inflation affect the cost of goods and services?

The primary effect of inflation on the cost of goods and services is higher prices. It can happen due to the following factors:

●  Raw materials become more expensive, forcing companies to increase their prices to keep up with production costs.

●  Employees require higher compensation, thus affecting production costs. Businesses pass on the extra expense to consumers so they can break even.

●  Less saving means more spending, thus more demand. Businesses must increase prices to keep up with supply demand through more employees or better equipment.

How Can a Company Compensate for Inflation?

As inflation takes over, it is the responsibility of employers to compensate employees better. It is necessary first to achieve good retention rates and, secondly, to attract top talent into the company. So what are employers doing for their employees during inflation?

●  Discount programs

Employers can offer discount programs for their employees for various goods and services. For example, they can partner with certain supermarket brands for discounts on produce.

●  Tuition support

Employers can offer bonuses to employers who are pursuing higher education in the form of tuition support.

●  Subscriptions

Some employers are also offering paid subscriptions as a way of helping employees deal with inflation. For example, employers can offer to pay for entertainment subscriptions or Wi-Fi.

●  Focus on well-being

More employers are offering healthcare support to help employees deal with inflation. For example, hiring an in-house counselor allows employees to have time to tend to their mental wellness.

●  Flexible working conditions

Some employees are allowing workers to work remotely or in a hybrid system. More flexible working hours means employees can pursue side hustles or career development programs. Plus, they will cut costs on commuting and in-office expenses.

●  Regular payments

It can be tough to wait a whole month for salary if the employee struggles to make ends meet. Therefore, some employees offer more frequent payments, such as hourly wages, weekly or bi-weekly.

Should Companies Raise Salaries Because of Inflation?

Mid-2022, some companies settled on raising their employees' salaries to cope with inflation. Walmart, T. Rowe Price, and Microsoft gave their employees salary increases to cope with retention concerns.

That begs the question, should employers raise salaries because of inflation? Considering there are other ways to help employees to deal with inflation, this is a legitimate concern.

The notion that increasing salaries often leads to a direct increase in inflation since production costs go up does not hold in some cases. For instance, if inflation directly results from the pandemic, denying an inflation-adjusted salary increase will not solve the problem, and increasing salary will not hurt it.

Employers should seriously consider increasing salaries for their employees to cope with inflation. The stress of being unable to make ends meet can also put a mental strain on employees, significantly affecting productivity and willingness to work. This can often lead to low retention rates as employees pursue other ways of making more money.

Therefore, the question should lean towards ‘how much,’ not ‘should.’ Employers should find a sustainable way to increase employee salaries to retain employees and attract top talent.

Depending on the company, there are multiple ways to do this. Some companies like ExxonMobil gave multiple share profits as a one-time bonus throughout the year to help deal with inflation. Others, like Walmart, offered an employee pay adjustment in the middle of the year. Some companies even offer two salary adjustments in the year instead of one.

The Bottom Line

Inflation affects employment and compensation significantly. Business owners must find sustainable but effective ways to help employees deal with inflation– for employee retention, better productivity, and to attract top talent.

Get in touch with Workpay to learn more about the benefits and wage increase rates that can help employees navigate inflation without leaving their positions.

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Workpay is a HR and Payroll software company that offers time & attendance, payroll, human resource, leave, expenses and remote teams solutions to businesses across Africa.

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