By Jim Cline and Kate Kremer
More often than not, employers prefer a fixed percent COLA adjustment, as opposed to a number tied to the CPI. Having a fixed percentage COLA number written in the “out year” labor contract settlements provides the employer a “known” number to plug into their budgets. While your members have often preferred the ability to keep full pace with inflation, the recent falling and erratic CPI numbers pose a new question: Would you be better off with your contract settlements tied to a fixed percentage increase?
Of course, any evaluation of a wage settlement turns on your particular situation and the overall terms of the agreement. But all things considered, our current advice is that bargaining teams should strongly consider a fixed percentage increase in lieu of a CPI formula.
Pre-recession CPI numbers generally floated close to 3%. When the bottom of the economy fell out in the fall of 2008, inflation numbers plummeted as well. For the two years that followed, CPI reports were negative (below 0%) or near negative. When the economy recovered, the CPI rose, but since that time the Federal Reserve Bank has used a target of 2% for inflation, not returning to the previous 3% benchmark.
Contract settlement expectations were adjusted along with that drop in the inflation benchmark. Settlement trends closer to 2-2.5% have become common.
In the past, CPI formulas have been incorporated into contracts with a “floor” and “ceiling” indicating a minimum and maximum CPI adjustment that would be applied to the wage rate. For example, in prerecession contracts, a range of 2-5% was common.
But with inflation periodically dipping below 2%, it’s easy to anticipate that employers are now much more reluctant to agree to a 2% floor. That floor might be attractive to your members because it provides a minimum guaranteed wage increase, but employers are now reluctant to extend such a high guaranteed minimum while also incurring the risk of paying more if inflation spikes.
Our evaluation of contract settlements had led us to conclude that fewer and fewer contracts were being settled using the CPI formula. Parties are electing on a more widespread basis to opt out of a CPI formula, in favor of a fixed percentage. To verify that anecdotal conclusion, we actually did a deep dive into the numbers. Looking at Washington law enforcement settlements since 2006 (other classifications appear to follow a similar trend), we are now able to document a significant fall in the use of CPI formulas in contracts.
In 2006, our pre-recession baseline, nearly 30% of contracts included a CPI formula. Now that number has fallen to nearly 20%. This chart shows this trend, identifying 5 years of settlements since 2006:
Year
2006 2008 2009 2013 2014 Wage Increase Based on CPI 47 47 53 32 30 Settled Contracts 157 164 164 152 137 Percent of Settled Contracts Based on CPI 29.94% 28.66% 32.32% 21.05% 21.90% Wage Increase Based on CPI with No Minimum 7 12 17 15 8 Percent of Contracts with Wage Increase Based on CPI that do not have a Minimum Increase 14.89% 25.53% 25.53% 46.88% 25.53%
The chart also reveals that among contracts that retain the CPI, a declining number contain a guaranteed “floor.” We think both the declining use of the CPI and a guaranteed floor arises from disagreements among the parties about what that floor would look like. Unions would still prefer at least 2% and employers would prefer no floor or, at least, no more than 1%. Our experience and data evaluation leads us to conclude that more and more parties are finding that adopting a fixed percentage is simply an easier path to reaching an overall agreement.
Whatever election you make in negotiations involves risk. Inflation could spike and if you’ve adopted a fixed percentage you’ll lose out on a potential for a higher number, one that would have kept pace with that higher inflation. But recent experience indicates that there is downside risk as well to that election. If inflation is low or negative, especially without a floor, your wage increase will be small.
Our prediction is that as more labor settlements include a component designed to “keep up” or “catch up” with a more competitive labor market, it is increasingly likely that the overall terms of the settlement will include a fixed percentage wage adjustment. Bargaining generally involve balancing the separate interest of the employees and the employer and this points to a fixed percentage as an increasingly common compromise.
Preparation for your negotiations should include a thorough review of market and settlement trend data, as well as inflation trends. For current information on these trends, visit our Premium Website.
