What Is the Employment Cost Index (ECI)?
The Employment Cost Index (ECI) is a quarterly economic series published by the Bureau of Labor Statistics that details the growth of total employee compensation. The index is prepared and published by the Bureau of Labor Statistics (BLS), a unit of the United States Department of Labor.
It tracks movement in the cost of labor, as measured by wages and benefits, at all levels of a company. The data is broken down by industry group, occupation, and union vs. non-union workers. The data is compiled through separate surveys of non-farm businesses (about 4,500 sampled) and state and local governments (about 1,000 sampled). The index has a base weighting of 100.
Wages track the amount employers pay in salaries and hourly labor while benefits measure a combination of health insurance, retirement plans and paid time off. Employees typically see their paychecks broken down into these two parts with a lion's share of the payment coming from wages. Employers use the index to evaluate the labor market and the amount of raises they can dole out each quarter.
- The Employment Cost Index is a BLS survey of employer payrolls conducted that measures the change in total employee compensation each quarter.
- It is used by a wide variety of stakeholders—economists, investors, employers—to track the state of the economy or set payscales for their employees.
- It can be volatile when bonuses and periodic compensations are taken into account.
Understanding the Employment Cost Index (ECI)
The Employment Cost Index essentially measures the change in total employee compensation each quarter. It is based on a survey of employer payrolls conducted by the Bureau of Labor Statistics in the final month of each quarter. The idea is that wage pressure increases in lockstep with inflation because compensation tends to increase before companies hike prices for consumers.
Therefore, it is considered an inflationary tailwind when the Employment Cost Index exhibits a steepening trend line or a greater than expected increase for a given period. In addition, as inflation increases, yields and interest rates also rise, resulting in a decrease in bond prices.
Economists use the index to measure the change in labor costs and gauge the health of the economy. It shows how the cost of compensating employees changes each passing quarter. An upward sloping trend generally represents a strong and growing economy. In other words, employers are passing on profits to their employees through wages and benefits.
Employee benefits are calculated as cost per hour worked across 21 benefits, ranging from Social Security to paid time off for holidays. The survey covers all occupations in the private economy, excluding farms and households, and the public sector, minus the Federal government. The BLS publishes estimates for each of these categories in addition to seasonally adjusted and non seasonally adjusted headline numbers.
Businesses and the federal government use the index for two different reasons. Employers observe the index to make appropriate adjustments in pay and benefits over time. If the index jumps 2% from the previous year or quarter, an employer may be inclined to give workers an equivalent raise. In some cases, employers may offer a larger raise to attract the best talent. Government agencies, on the other hand, watch the benchmark index to gauge the health of the economy. It can inform officials when the economy is overheating or when wage growth signals an uptick in inflation.
The ECI is watched by investors largely for its inflationary insights. Wages often represent the lion's share of the total cost for a company to produce a product or deliver a service in the marketplace. The relative percentage will vary by industry, making the data release valuable on an inter-industry level.
ECI is one of the main economic indicators used by the Federal Reserve to set monetary policy. Another benefit of the methodology used in the ECI is that wage changes that occur as a result of a shift in the occupational mix of workers can be captured here using a "basket of occupations" approach similar to that of the CPI. Results of the ECI are less likely to be affected by people shifting to lower or higher-paying jobs.
ECI is a lagging indicator; rising costs at this level speak to economic overheating that has already been visible at earlier points in the economic food chain (commodity costs, retail sales, gross domestic product), and suggest that some rise in inflation is inevitable.
This indicator can move the markets if it shows marked differences from street estimates. If demand for a business's products is relatively price inelastic, rising compensation costs can be passed on to consumers because they are such a large corporate expense.
The ECI is part of the formula that is used to calculate productivity. Investors should always compare the ECI to total productivity figures, paying particular attention to relative rates within industries in which they have a stake.
Advantages of ECI:
- The ECI calculates the total set of employee costs to businesses, not just wages. Health insurance, pensions and death-benefit plans, and bonuses are all calculated here and broken out separately from wages and salaries.
- Data is provided with and without a seasonal adjustment.
- The ECI is well respected by both the Fed and business leaders; company managers use the ECI to compare their own compensation costs relative to their industries.
- Rates of change are shown from the previous quarter and on a year-over-year basis.
Disadvantages of the ECI:
- The data is only released quarterly, and with a slight overlap, covering a mid-month period.
- Hourly earnings shown in the monthly “Employment Situation Report” provide some headway into each release, taking some of the surprise value out of wages.
- ECI can be volatile when periodic bonuses, commission payments and the like are taken into account (especially at year-end); economist interpretation is often needed to fully digest the report.