Employment Costs: This Often-Ignored Index Deserves a Closer Look

From accelerating U.S. GDP growth to rising corporate revenue, signs are indicating that the current economic expansion will continue to produce good news for investors in the quarters ahead.

However, while the two stats above speak to a business's top line, investors shouldn't overlook some news that helps the bottom line: employment costs -- which rose a less-than-expected 0.4% in the fourth quarter and just 2% in 2010 overall -- the second-lowest, full-year rise since 1982. The lowest came with 2009's 1.6% increase.

In the fourth quarter, wages and salaries, which make up about 70% of total employment costs, and benefits, which make up the remaining 30%, each rose 0.4%.

Under the Radar

Compiled quarterly by the Labor Department's Bureau of Labor Statistics, the employment cost index (ECI) usually gets little attention from the general media. Experienced investors, however, know it's a statistic worth tracking.

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The reason? The ECI measures companies' costs for staff: salaries, wages, benefits as well as the portion of Social Security and Medicare taxes paid by businesses. In that sense, the ECI is sort of a "workforce inflation index."

Throughout 2009 and 2010, the ECI continued to show that business costs for staff remained under control. That's partly because vigilant cost-controls by businesses kept employment costs contained in 2010 -- with salaries rising 1.6% and benefits costs increasing 2.9%. Part of it also stemmed from outsourcing to lower-cost labor markets, ongoing improvements in productivity, and the country's high unemployment rate, currently 9%. Typically, during periods of high joblessness and few opportunities, employees have less bargaining power, and that's certainly been the case during the Great Recession and through the first 18 months of the recovery.

Of course, the small wage gains also have a downside: Median incomes won't get the kind of boost they would when employees have more bargaining power. This could weigh on consumer spending, upon which much GDP growth depends.

Buying Time for the Fed

Still, the upside could be larger and longer-term because it will help keep inflation, currently running at a low 1.5% annual rate, in check.

And that low inflation rate will give the U.S. Federal Reserve more time to stimulate the economy via its asset-purchase program, QE2.

The tiny employment cost increase is, therefore, one factor keeping QE2 stimulus in place, which should help the U.S. economy progress to a self-sustaining expansion -- the virtuous cycle of rising demand, rising corporate revenue and, eventually, rising job openings. And a self-sustaining expansion with rising corporate revenue is good news for U.S. stock markets.

Watch Out for Commodity Prices

It's important to note that employment costs aren't the only component of inflation. Commodity costs (especially crude oil and raw materials) are another, and if they surge in 2011, that could push up inflation and prompt the Fed to begin withdrawing its stimulus or raise short-term interest rates, or both.

But absent that, the restrained employment cost index will do its part to keep inflation in check and the Fed's stimulus plan in place -- not bad for a statistic that gets little attention.
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