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Recession, layoffs, inflation, worker shortages. What it all means for 2023 pay increases

By Lori Wisper | January 30, 2023

Making sense of the external factors that may sway your decisions as you head into the 2023 annual pay cycle.
Compensation Strategy & Design|Workers Compensation

Are we confused yet? It’s a natural question given the headlines about the U.S. economy heading into a recession, the alarming spread of layoffs (particularly in high tech), continued high inflation and the undeniable – yet stubborn – reality of labor shortages, all against the backdrop of the Federal Reserve’s continued push to raise interest rates.

What does it all mean as organizations plan for 2023 salary increases? We break it all down to identify the best courses of action and the best way to communicate those actions to employees.

Recession: Are we there yet?

The “recession is coming” message is reminiscent of those childhood trips when the journey seemed unending and you kept asking “are we there yet,” without the fun destination. While this already happened in the U.S. when GDP decreased 1.6% in the first quarter of 2022 and 0.6% in the second quarter, the economy grew by 3.2% in the third quarter and the fourth quarter also grew by 2.9%!

Given the second half growth of 2022, when it comes to recession, we’re actually not quite there yet, according to the National Bureau of Economic Research (NBER), which is considered the preeminent expert at predicting business cycles. NBER defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”

Regardless of whether we are “there” yet, it may be more relevant to put what feels like an inevitable economic slowdown into perspective by considering these facts:

  • Up until the 2020 pandemic driven short-lived period of economic decline, we were in the longest business expansion in U.S. history
  • Between the Great Recession and the COVID-19 recession (which only lasted February to May, the one exception to the NBER’s definition because it was such a steep decline that impacted so many people), the U.S. economy grew for 127 months – the longest on record since 1854
  • By May 2020, the economy was expanding again thanks to government aid and less restricted unemployment payments
  • GDP growth in 2021 topped out at 5.9%, the highest level of growth since 1984 despite the ongoing pandemic. By comparison, GDP growth had been between 1.5% and 3% a year since recovering from the Great Recession in 2010
  • For all of 2022, GDP expanded 2.1% driven by U.S. consumer spending even with inflation and higher interest rates

The pandemic propelled the economy to grow in ways it never would have without it, and now we are experiencing a period that’s taking us back to what normally would have been a slower, more typical growth rate. Based on data from The World Bank, with the jump in U.S. GDP from 2020 to 2021 – a 9% increase compared to a 6% decline from 2019 to 2020 – it’s understandable that 2022 would suffer by comparison.

What this means for 2023 pay increases

“Should we take a more conservative approach to setting salary increase budgets given the impending recession?” is the question recently asked by a client in the financial services industry. Keep in mind, this company expected strong 2022 revenue growth (and even better profits).

Like all significant expenditures, salary increase budgets should be driven by multiple factors, with affordability at the top followed by the competitive labor market landscape. Certainly, if an organization is experiencing economic loss (or even slow growth), a conservative approach to setting salary increases budgets is prudent. However, that approach should be taken with the organization’s financial and competitive situation in mind rather than what’s happening in the broader economy.

If an organization in growth mode decides to limit salary increases based on fears of an impending recession, they risk not only turnover in a highly competitive labor market but also a potential loss of trust and credibility due to mixed messages. When leadership thanks employees for their hard work that led to business growth and helped the organization reach financial goals but then delivers salary increases that are below competitive standards, the resulting perceptions are confusion at best and anger at worst.

Should you take a more conservative approach to setting salary increase budgets because of an anticipated recession? Perhaps, but only if it makes financial sense for your organization and only after weighing how it may affect your ability to attract and retain employees this year and beyond. Organizations with salary increases below competitive levels erode their long-term competitive pay position – and usually don’t realize it until years later when they can’t stem turnover or attract the talent they need.

But what about all the layoffs? 

Certainly, some organizations are experiencing an economic slowdown if not outright shrinkage. In fact, Jennifer Liu coined the term “loud layoffs” in a CNBC article, noting that layoff announcements by well-known tech giants have resulted in more than 150,000 tech workers losing their jobs. While the term refers to actions that are garnering significant airtime on social and traditional media given the marquee company names involved, these involuntary terminations don’t represent what’s actually happening in the broader U.S. economy.

The U.S. Department of Labor’s November jobs report showed the strength of an already hot market that reflected much higher-than-expected growth (256,000 jobs created versus 200,000 expected) and a low 3.7% unemployment rate. And this was after the Fed’s effort to slow job growth with multiple interest rate hikes. The more recent December jobs report also showed a better-than-expected outcome, with 223,000 new jobs created, the unemployment rate falling to an historic 3.5% low and more people entering the workforce.

Just as we consider the broader picture when discussing an impending recession, we also should take a broader perspective when diagnosing the labor market. 2022 job growth averaged 375,000 jobs per month compared to the average of 194,000 per month from 2011 to 2019, according to a report released by the White House. Clearly, 2021 and 2022 represented a jump in job creation that far exceeded anything seen in the prior decade.

While layoff headlines certainly have become “loud,” do they really reflect what’s to come? Or are they a correction in industries that experienced huge growth based on the pandemic anomaly? Amazon certainly was a pandemic “winner,” and the fact that they doubled their workforce from 798,000 employees at the end of 2019 to 1.6 million by the end of 2021 shows the exponential growth they and others in the e-commerce industry experienced. It is notable that Amazon’s 2022 layoffs were the largest in its history, but also represented less than 2% of the company’s global workforce (about 28,000 employees). That means the company still has about 774,000 more employees than it did in 2019. Is that true shrinkage or a correction?

What this means for 2023 pay increases

You won’t find it in the headlines, but even organizations conducting layoffs will still budget for and provide 2023 salary increases. Why? Because they still have job openings – even amid layoffs – and they still have most of their workforce to retain, which includes paying competitively. In fact, most organizations planned to spend more on salary increases in 2022 than they did in 2021, according to WTW’s December Salary Budget Planning Report. And they anticipate spending even more in 2023 than they did in 2022 in response to a competitive labor market and inflation-fueled employee expectations.

Unless your organization is considering a workforce reduction, loud layoffs shouldn’t influence how salary increase budgets are set or how much salaries are increased. The dichotomy of current economic conditions is confusing for sure; however, organizations that are slowing their hiring rate but not considering layoffs need to budget and provide salary increases that effectively sustain the workforce.

Layoffs in the high-tech and e-commerce industry provide a valuable salary increase-related lesson. This industry has always been known for paying richly compared to other industries, and their salary increase budgets often are the highest going rates published. While it appears these companies over-hired to manage continued anticipated growth, that didn’t materialize – and they likely overspent on top of it. That’s the lesson: When you overspend on pay, the ONLY way to correct for it is layoffs.

Yes, we’re still talking about inflation and pay

In January 2022, U.S. inflation hit 7.5% – the biggest 12-month increase since February 1982 – after having been well below 3% for the prior decade, including the first two months of 2020. The 2021 year-end high continued growing throughout 2022, rising as much as 9.1% in June until finally receding in December to 6.5%.

As if we weren’t already keenly aware of the higher prices that we experience every day as well as the toll they take on our buying power, the constant media spotlight on “salaries aren’t keeping pace with inflation” continues to drive questions about salaries and inflation. Those questions were a constant drumbeat in 2022 and will likely hit a crescendo as we head into salary increase season.

What this means for 2023 pay increases 

The average 2022 U.S. salary increase (including merit increases, promotional increases, collective bargaining increases and so on) was 4.2%, according to the WTW Salary Budget Planning Report – an increase from 3.0% in 2021. In addition, the 2023 projected average total increase is even higher, at 4.6%.

Remember: The last time we saw a U.S. salary increase budget number at or above 4% was 2007, 15 years ago, and the only time we have seen more than a 1% increase in salary budgets since we began tracking them in 1980. Also noteworthy is that, while salary increase budgets have dropped by more than a full percent (as they did from 2008 to 2009), they have never gone up by a full percent or more. Clearly the increase in salary budgets is a big deal, but even more significant is the actual amount of money behind these higher salary increases. While the media shouts about small salary gains for employees, higher budgets can represent hundreds of millions of dollars in increased costs for employers. The significance of this salary budget increase should not be understated.

So, why do you have to explain the reason why salary increases don’t match inflation for the 10,000th time? Because, while salary increases may hit historic highs, they still won’t match inflation of 6.5%, nor should they! Matching salary budgets to inflation is just bad business.

To explain this to employees, you may want to use the discussion about loud layoffs – in this case, the volume of layoff headlines is an advantage! As Figure 1 shows, if an employer matches salary budgets to inflation, when inflation goes down (as it’s fully expected to do in 2023), that employer is stuck with an over-inflated, above market-competitive payroll. And, as we’ve seen in the recent announcements, the ONLY ways to correct for this is layoffs, especially when business growth doesn’t support it.

That said, WTW research found that salary increase budgets will be bigger in 2022 and 2023 because of employee expectations regarding inflation and employers’ continued challenges around attracting and retaining talent.

Considerations related to worker shortage

In 2022, little was as uncertain as the future of the U.S. economy. What we did know was that workers were in short supply, and they will continue to be into 2023. Of all the topics covered here, worker shortage is the one that impacts salary increase budgets the most, yet it gets the least attention.

Worker shortage is also the single-most predictable factor, meaning we can plan for it. Back in 2013, many experts talked about the coming talent deficit of 2021, a prediction based mostly on the demographic reality of bigger generations of people/workers (Baby Boomers) being followed by smaller generations of people/workers (Gen X).

While we knew this was coming long before it arrived, we didn’t know that it would be exacerbated by a global pandemic and an immigration slowdown – perhaps a perfect storm of events that led to a worker shortage combined with a record number of people changing jobs in 2021. In their Harvard Business Review article, authors Joseph Fuller and William Kerr noted that the record number of employees who quit their jobs in 2021 was actually “the continuation of a trend of rising quit rates that started more than a decade ago.”

While many want to think that worker shortages and turnover are short-term issues created by the pandemic, Fuller and Kerr point out that “from 2009 to 2019, the average monthly quit rate increased by 0.10 percentage points each year. Then in 2020, because of the uncertainty brought on by the COVID-19 pandemic, the resignation rate slowed as workers held onto their jobs in greater numbers. That pause was short-lived.

“In 2021, as stimulus checks were sent out and some of the uncertainty abated, a record number of workers quit their jobs creating the so-called Great Resignation. But that number included many workers who might otherwise have quit in 2020 had there been no pandemic. We’re now back in line with the pre-pandemic level, which is one that American employers are likely to be contending with for years to come.”

What this means for 2023 pay increases

Of all the uncertainty employers faced at the end of 2022, they could count on still being challenged to attract and retain talent in 2023 and beyond. Given this reality, there are considerations for salary increases as well as other actions employers can deploy.

  • Use the ‘Goldilocks’ method for setting salary increase budgets

    Not too big, not too small, but just right. The uniqueness of the times calls for salary increases that are neither too conservative nor generous, meaning that organizations should gather plenty of data to truly understand what “competitive” means in the labor markets in which they compete for talent. Employers also should re-examine how their competitive labor market has changed.

    Unlike prior years, many employees who quit in 2021 left to go to other industries. If you collect market data for your industry alone, you may be missing the full picture of what “competitive” truly is. For example, airline workers who lost their jobs in 2020 may have gone to work at manufacturing plants, hospitals, fulfillment centers or retailers. Using airline data alone limits your view of the competitive landscape.

  • What else ya got?

    Ensure other reward elements such as short- and long-term incentives, recognition programs, benefits plans and even less-tangible rewards like flexibility, culture and purpose are not only competitive, but focused on what employees – both current and prospective – prefer, value and find meaningful. This means understanding those preferences through research and employee listening. It also may mean thinking differently; that is, look beyond labor-market competitors and creatively think of new ways to define and differentiate the overarching employee experience.

  • Segmentation is key

    It’s time to do away with the one-size-fits-all approach to rewarding employees. Employers that recognize the needs and preferences of different employee cohorts and design reward programs with those in mind will effectively create a cornucopia of different offerings that will win both today’s and tomorrow’s talent wars. What you provide to frontline hourly workers should not be the same as what you provide to corporate knowledge workers. This has always been true, but it’s never been more important in finding and keeping employees.

  • The medium is the message

    Reward programs are a medium for messages and organizations should think about the messages they’re sending, particularly related to salary increases. If employees still believe that salary increases should match inflation, what does that say about the intended and unintended messages sent through those increases?

    If your organization espouses a pay-for-performance approach to increases but employees don’t understand what that means or see little to no performance differentiation, the unintended message may be that salary increases are meant to provide for their cost of living rather than the organization’s cost of labor. Always think of pay programs as a communication vehicle first, then decide whether your messages are the ones you intend to send.

Nothing is certain as we start yet another year but, hopefully, for now this helps you navigate the current economic minefield to make effective pay decisions that you can feel good about communicating to employees.


Managing Director, Work & Rewards
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