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3 insights for learning to manage with inflation again

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Peter Cappelli
Peter Cappelli is HRE’s Talent Management columnist and a fellow of the National Academy of Human Resources. He is the George W. Taylor Professor of Management and director of the Center for Human Resources at The Wharton School of the University of Pennsylvania in Philadelphia. He can be emailed at hreletters@lrp.com.

It’s time to find the oldest person in your office and ask them what it was like to run human resources when inflation was last important. That would be 40 to 50 years ago. It is remarkable how persistent a worry it has been over the last two generations despite not materializing. But now it is back, rising at an annual rate of over eight percent, which is almost triple what we had been used to.

Inflation is defined as increases in overall prices in the economy that makes your money worth less—a dollar buys fewer goods and services after price inflation than before. It is measured by the Bureau of Labor Statistics in a decidedly old-fashioned way—by going around and seeing what things cost in stores and other places across the U.S. When we say that inflation is up by eight percent on a yearly basis, that means the basket of goods we are pricing costs eight percent more now than it did a year ago.

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Inflation averaged 6.8 percent in the 1970s, about double earlier periods, but the big problem is that it jumped around a lot with the sharp increases in oil prices from OPEC when it pulled back supply. Fuel prices tripled between 1973 and 1974. (Ask your older colleagues about odd and even day rationing for gasoline.) Then they jumped again in 1979. Those price increases immediately translated into big rises in gasoline and heating oil in particular, and they pushed up prices for everything that used petroleum. That is true now as well: Half the current increase in inflation is due to increases in oil prices.

The problems inflation causes for management begin with the fact that people suddenly feel and indeed are poorer. Even if inflation falls to zero right now, most of us have lost out a lot already: Average wage increases have been less than half the rate of inflation, which means that despite the punditry about high wages, they are still falling in real terms by a fair bit.

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Inflation doesn’t impact everyone equally in part because prices don’t all go up equally. Employees who already owned homes and locked in mortgages did pretty well, while those just starting out suffered a lot, especially when mortgages accelerated.

An employer might say, “so what,” this is an economy-wide problem and not something I can address for my employees. In the 1970s, unions and contractual cost-of-living increases forced employers to do something about that by raising wages. While that is not the case now, it nevertheless becomes an issue when employers are hiring—and that is all the time—because new hires expect to get increases in pay, and they expect to be compensated for inflation that will happen after they join. If we address inflation with our hiring offers and not with current employees, then we have big compression problems between those current and new employees that will be hard to ignore.

A second issue has to do with the fact that if we respond to inflation with higher wages, that is likely to be executed through the merit pay process, and merit pay increases will become dramatically bigger. When we were stuck with the three percent budgets for pay, good performers might get five percent and poor ones may get little or nothing. But if the budget keeps up with inflation at eight percent, then the very best performers might get 16 percent, and if others get close to zero, with prices rising, those differences have real teeth. Any unfairness in those processes for setting merit pay really matters: Expect a lot more grievances and complaints about it.

Also see: ‘Time for employers to take action’ on soaring healthcare costs

A third set of issues relates to the fact that inflation is likely to be unpredictable. In the 1970s, it jumped twice to over 12 percent and also down to just over three percent. That is the real nightmare for employers because we can’t easily plan for it. The likely response is to not plan and instead try to catch up after with wage increases, which means we are always behind. Employees also want to know how their employer will respond, and CFOs don’t know and don’t want to commit.

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The context where this uncertainty over inflation matters the most is probably with the army of vendors that we use in human resources and their contracts. When any seller locks in a deal, including HR vendors, they are taking a risk that the price they are being paid isn’t going to be eaten up by inflation. They want protection from those uncertain increases by getting clients to agree to bigger increases upfront or cost-of-living adjustments.  Clients don’t want to give it to them. A likely response is shorter contracts, which means more of them, and more negotiating.

At least the tight labor market has benefits for employees. Inflation is just a bother for everyone.