Will Moderate Compensation Gains Assuage U.S. Inflation Fears?

Why Are Benefit Gains Decelerating So Dramatically?

Much of the deceleration stems from falling contributions to pension trusts in 2006. Rebounding financial markets and slowing corporate profit gains altered the incentives for corporations to contribute to their pension funds. As large pension trusts turn self-sustaining in the face of a bull market, companies contribute less. In addition, the record corporate profit growth has decelerated, meaning less incentive to shore up pension funds in tax-friendly trusts. These factors converged last year, removing the incentive structures that drove companies to contribute wildly to pension funds in prior years.

The aircraft manufacturing and utilities industries showed marked declines in benefit costs during the first quarter of 2007. Costs for aircraft manufacturers fell 12.7% in the quarter, not seasonally adjusted. Benefits for utilities are not published directly by the BLS, but Global Insight has deduced that benefit costs fell approximately 3.8% in the first quarter, based on the changes in compensation and wages. Because the utilities sector is much larger than aircraft manufacturing, this decline offsets benefit growth for total private industry by 0.3 percentage point, rather than the 0.1-percentage-point impact registered by the aircraft manufacturing decline. Together, these declines sliced 0.4 percentage point from total private industry benefits growth.

In the aircraft manufacturing sector, pension trusts were fully funded via market performance alone throughout the 1990s. When the market turned down, though, large contributions were necessary to keep the trusts fully funded. Boeing alone contributed $4.4 billion to its pension trust in 2004, causing the ECI for benefits, aircraft manufacturing series, to gain 36% in the first three months of 2005. Now that the pension trusts are in good shape again, contributions have fallen off markedly, dragging the ECI for benefits in aircraft manufacturing down as well. Utilities have also backed off their pension contributions. Pacific Gas and Electric discovered that a strong 2005 performance reduced the need for pension contributions last year by $118 million. While changes in pension contributions during 2006 (which are accounted in first-quarter 2007) may have affected aircraft manufacturing and utilities sharply, it is likely that many industries responded to changing incentives to contribute to pension trusts in a similar, if more muted, manner.

Benefit gains for unionized manufacturing workers were muted in the first quarter. Compared with a 4.2% year-on-year (y/y) increase in the fourth quarter of 2006, these workers received a mere 1.6% y/y increase in the first quarter of 2007. While concessions in the struggling automobile manufacturing and airline industries are a reality, much volatility stems from the fact that a higher percentage of workers in transportation equipment and utilities are unionized, and thus have pensions. So, the reduction in pension contributions is most likely feeding through to the recorded benefits costs of these workers more readily than for non-union workers.

Global Insight predicts benefit cost gains will accelerate slightly in the second quarter, as pension contributions no longer exert a drag on the ECI for private industry benefits. Pension contributions are only incorporated into the index once a year—in the first quarter—removing the possibility of driving further benefit costs deceleration in the second quarter. Therefore, Global Insight expects compensation growth to accelerate slightly in the second quarter. Wage pressures will moderate, though, and compensation growth will not accelerate to a pace that could fuel inflation fears.