Additional Geographic Assessor Topics (Listed Alphabetically) > COL Differentials vs. Wage/Salary Differentials

An important distinction to make when using the Geographic Assessor is to differentiate between cost of labor and cost of living. Both are based on supply and demand, but the values being measured are different. Cost of labor is based on the supply and demand for labor in a labor market. Cost of living is based on the supply and demand of a specific market basket of goods and services in expenditure categories. Each is calculated from a distinct and separate database.

Cost of Labor

Average market rates of pay determine the cost of labor in a given labor market and can be used to create geographic pay differentials to do things like adjust salary structures to match local labor costs. The Geographic Assessor uses local salary survey data to determine these market rates and construct the geographic differentials. ERI collects base wage and salary surveys and regresses weighted average data to the derivation of area structures. Stated more simply, we compare the pay of similar jobs in locations to a benchmark, like the US Average pay, for those jobs to determine the pay trend for each location relative to that overall US Average. This addresses the question, "At various salary points, are the labor cost trends higher or lower than the base and by how much?" For international locations, we use the national average of the respective country as the benchmark. There are some characteristics of labor markets to consider, like salary level and commuting distance. In terms of salary level, a city can have multiple labor markets at the same time. For example, there may be a surplus of workers at low wage rates and a deficit at professional or managerial rates, and that can impact the geographic differentials at different salary levels. Additionally, labor markets tend to broaden in size as salaries increase, which tends to push the geographic differentials toward the national average at the highest salary levels. For example, many companies have a separate salary structure for executives that is not adjusted for geography (since other factors, such as industry, company size, or performance, drive compensation at those levels). For these reasons, we look at the labor cost trends across eight different salary bands concurrently. In terms of commuting distance, labor markets tend to be broader than housing markets used in cost of living, for example, so the cost-of-labor differentials tend to be rather consistent throughout a commuting radius. Labor also has the general ability to commute, so geographic pay differentials tend to be fairly consistent throughout metro areas.

Cost of Living

Cost of living is determined by pricing a representative market basket of goods and services in different locations. ERI researches local costs including housing, transportation, consumables, taxes, and others to compose a market basket. The Geographic Assessor will compare the costs between locations and report the overall cost differential based on the cost difference of this market basket. Some versions of the Geographic Assessor will also report the breakout of each market basket line item for direct comparison at the item level. Like cost of labor, cost of living can vary by income level (there could be a shortage of inexpensive housing but a surplus of larger homes, for example). Unlike most labor markets, certain components of the market basket can be very restricted by geography, particularly housing, where there can be sharp differences in price across very small distances, such as ZIP codes, neighborhoods, or suburbs. As a result, there can be significant fluctuations in cost of living within a metro area depending on the particular housing market. In addition, cost-of-living differentials can vary when one considers the rental housing market versus the ownership market (there could be a surplus or deficit of one and not the other). Cost of living is measured to determine overall out-of-pocket cost differences between locations. This can be particularly relevant for situations like company-initiated relocations, where salary adjustments might be based on the cost-of-labor difference, but a relocation package may be assembled to additionally assist employees in adjusting to the different cost of the new location.

Relationships between the Two Costs

There is a common component between cost of labor and cost of living – the workforce that is paid the salary and subsequently purchases items in the market basket. This can result in a correlation between the two, though definitely not a perfect one. For example, in places where salaries are higher, workers can spend more on goods and services, which tends to push market prices up through demand. Also, places that have a high relative demand for labor tend to draw in workers and would need higher salaries to do so, and the increase in the workforce can put pressure on the housing market, thus increasing costs. However, the opposite can occur when workers are attracted to a location for reasons besides demand for labor – this increases the supply of labor and can keep labor rates flat, while still putting pressure on the housing market (for example, in parts of California, increases in housing costs can exceed the ability for the local workforce to keep pace through higher salaries). There is also the potential for cost of living to be much more extreme than cost of labor – for example, both costs are above average in Manhattan, but, housing is so expensive in Manhattan that most workers there do not live there (and those that do often live in smaller housing units than they would otherwise). These examples are not meant to be comprehensive but are offered to illustrate the differences between cost of labor and cost of living as the interrelationship between the two can be complicated.

Of course, there are many uses for these types of data based on company compensation philosophy. This article is intended to provide background on the similarities and differences between the two measures and some frequently used examples.

See Salary Structure Variances for more information.