Why Small Businesses Haven’t Been Giving Raises


Pay at small businesses has been largely flat for the last 25 years.

Don’t think that means workers aren’t deserving of raises. They’re working harder now than they were nearly a quarter century ago. In fact, worker productivity has increased 60 percent between 1990 and 2012, Bureau of Labor Statistics data shows.

So why isn’t the rise in productivity translating into raises for workers? The answer, it appears, is that all gains that have come from their increased productivity have gone to fund rising worker benefits and pensions. Workers are earning more in inflation-adjusted terms; they just aren’t getting more cash.

Economics tells us that, in the long run, real employee compensation tends to rise in proportion to increases in worker productivity. But all compensation isn’t cash. Some of it takes the form of benefits, such as health insurance and retirement plans. More importantly, the balance between cash and benefits can change over time. Businesses can allocate all of the increases in worker compensation to wages or to benefits or a mix of the two.

Some economists believe that rising benefits spending at small businesses has sucked up the entire rise in compensation resulting from increased worker productivity over the past two decades. As a result, the total compensation of small business workers has risen, but their wages have remained flat.

Data from the Bureau of Labor Statistics (BLS) and the Internal Revenue Services (IRS) is consistent with this story. While output per worker rose 60 percent over the past twenty-plus years, the average hourly wage at establishments with between one and 99 workers increased by a paltry 0.9 percent, when measured in real terms.

However, the amount that small establishments boosted employee benefits has been in line with the increase in worker productivity. IRS data shows that sole proprietors increased their spending on pensions and profit sharing from 1.3 percent of labor costs in 1980 to 3.8 percent in 2011.

Between 1990 and 2013, the amount that small establishments spent on employee retirement benefits increased by 64 percent in inflation-adjusted terms. And from 1991 to 2013, the amount that small establishments spent on employee health benefits increased by 68 percent in real terms, BLS figures show.

Stated bluntly, all of the additional worker compensation that resulted from increased productivity over the past two-plus decades has gone into workers’ health and retirement benefits, with nothing left over for raises.

For those employed at small businesses to earn more cash in the future, they can’t just become more productive. Instead, less of their raises also have to go to benefits and retirement income.

Pay Check Photo via Shutterstock

Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.