Labor Costs Tell the Tale

The ECI predicts where profits may be headed

Without even thinking about it, you can probably reel off your annual salary. But do you know the value of your benefits? Likely not. Yet benefits make up a big chunk of your compensation--and are a significant cost to any business.

Amid the current dismal outlook for profits, Wall Street is especially interested in labor costs since rising pay could mean even greater declines in profits. That's why investors should pay attention to the Labor Dept.'s Employment Cost Index, a quarterly measure of what companies spend on wages, salaries, and benefits.

Federal Reserve Chairman Alan Greenspan has indicated he watches the ECI to gauge profits, and for good reason, says Maureen Allyn, chief economist at Scudder Kemper Investments: "The ECI is the most comprehensive measure of labor costs. It gives the best sense of rising cost pressures being felt by businesses."

Certainly, other factors affect earnings. The sudden dropoff in demand, along with rising energy costs and the strong dollar, caused profits to swoon in the first half. But labor costs account for two-thirds of the average company's expenses, so they have a big impact on the bottom line. Right now, the ECI shows that employment costs rose 3.9% in the year ended in June, down from a 4.4% advance a year earlier.

In addition, some economists watch the ECI as a harbinger of inflation pressures, so the index also affects bond prices. Inflation hawks, including those at the Fed, are warning about potential price pressures in early 2002, when the economy is expected to rally. Some worry that jumps in health-insurance premiums could cause trouble. So, expect the ECI to play a role in setting monetary policy. If health-care or other costs accelerate, the Fed will be less likely to cut rates further.

The ECI tallies up what companies and state and local governments pay their workforce in wages, salaries, and benefits for each hour worked. Though there are other gauges of labor costs (table), the ECI has a few advantages. It covers more workers than the hourly wage series and is more timely than the compensation data in the Labor Dept.'s Productivity and Cost report. Most important, "it's hard to get a read on benefits anywhere else," says Allyn. And benefits are pricey. According to a separate annual survey done by Labor, benefits account for 27% of all labor costs.

To calculate the ECI, Labor surveys about 7,400 private companies and 800 state and local governments. The questions cover hourly pay and straight salary, and benefits ranging from overtime, health insurance, and paid vacations to Social Security taxes and workers' comp. Labor releases the report on the last Thursday of the month following the quarter's end. You can get it at www.bls.gov/news.release/eci.toc.htm.

With revenues expected to be weak at least into 2002, any profit gains will likely come from cost-cutting. So keep an eye on the ECI to get the best sign that Corporate America is holding down labor expenses. A rosier profit outlook should give a big lift to your portfolio.

By Kathleen Madigan

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