WilliamBlair Economics Weekly

Equity Research Macroeconomics

Economics Weekly Louis Mukama Record Profits, Lagging Pay

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The September employment report showed average hour- companies tell a similar story. The S&P 500 operating ly earnings up 3.0% from a year earlier, the slowest pace margins reached 15.7%—the highest level since 2022. since May 2021. On a year-ago basis, the Employment Cost Index (ECI) has also slipped and is below CPI infla- Margins can widen in two ways: companies can charge tion for the first time since early 2023. At the same time, more relative to their labor costs or workers can produce corporate profit margins sit at their highest level since the more relative to what they are paid. Since 2020, produc- series began in 1947, and labor’s share of output is the tivity has been the larger contributor to rising margins lowest on record. We have long argued that a shrinking than mark-ups (exhibit 2). That distinction matters pool of available workers could put more upward pres- because productivity growth creates room for wages to sure on wages and threaten those margins. Companies rise without adding to inflation. Yet, little of that room has responded to the labor shortage much as we expected, been used. Within the ECI for private industry, wages and by investing in capital and lifting productivity. What has salaries rose 3.1% over the past year, leaving inflation- not followed is a meaningful recovery in wages. In this adjusted pay down 0.4%. Over the same period, benefit Economics Weekly, we look at why pay has lagged in a costs increased 3.8%, suggesting a smaller share of com- tight labor market, and what that means for the Fed pensation growth is flowing through to take-home pay. and for investors. All in all, workers are generating more output per hour, but their purchasing power is still declining.

Productivity Is Rising; Pay Is Not Exhibit 2 Productivity & Mark-up For most of the past four decades, an abundant supply 1.20 Rebased to 1 = Dec 2020

of workers helped keep wage growth in check and sup- Productivity ported corporate profits. The labor shortages in the few 1.15 Mark-up

years ahead of the pandemic, and during it, started to 1.10 Mark-up x Productivity Series

change that, with compensation’s share rising. Following the pandemic, workers remain harder to find, giving em- 1.05 Productivity has been the main driver not pricing power

ployees more leverage and putting pressure on margins, 1.00

yet compensation’s share of output has been falling again sharply. Conversely, profit’s share of gross value added 0.95

has continued to climb (exhibit 1). 0.90 Mar-20 Mar-22 Mar-24 Mar-26 Mar-28 Mark-up = Implicit Price Deflator/Compensation per hour' Productivity = Output/Hours Worked Source: BLS, Peter L. Berstein Inc., William Blair Equity Research

Exhibit 1 Employee Compensation Share of Value Added vs Profits Share of Gross Value Added for All Nonfinancial Corporate Business Compensation Share, % Profits Share, %

66 15 Why a Tight Labor Market Hasn’t Lifted 64 13 Pay 62 11

Small businesses still report difficulty finding workers. 60 9 According to the NFIB’s September jobs report, 26% of 58 7 owners cited the quality or availability of labor as their single most important problem, 14 points above the his- 56

Total Compensation as % of Value Added 5 torical average. Yet only 6% cited labor costs, the lowest 54 Mar-70 Mar-75 Corporate Profits as % of Value Added

Mar-80 Mar-85 Mar-90 Mar-95 Mar-00 Mar-05 Mar-10 Mar-15 Mar-20 Mar-25 3 percentage since December 2020, and the net share of Sources: BEA, William Blair Equity Research owners raising compensation slipped to 28%. We see four reasons pay has lagged the shortage of workers. The productivity data show the gap most clearly. Over The first is a shift in spending from labor toward the past four quarters, output per hour in the nonfarm capital. Business investment has been one of the fastest- business sector rose 2.2%, while real hourly compensa- growing parts of the economy since the pandemic, with tion fell 0.1%. Workers produced more but received less real equipment spending up 13.6% at an…