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. These structures are derived from the collection and processing of current levels paid for numerous benchmark jobs in various major metropolitan areas. There are some characteristics of labor markets to consider, like salary level and commuting distance. A city can have multiple labor markets at the same time – that is, there may be a surplus of workers at low wage rates and a deficit at professional or managerial rates, for example, and that can impact the geographic differentials at different salary levels. Labor also has the general ability to commute, so geographic pay differentials tend to be fairly consistent throughout metro areas. Finally, labor markets tend to increase in size as salaries increase. Jobs with higher salaries tend to be more complex and require more extensive training and experience; consequently, they have more limited incumbent pools. Recruiting for these positions often is regional or even national, broadening the labor market. Since competition for labor is not localized, pay is higher regardless of location, which tends to reduce geographic-specific differentials. (Though, a relocation package may be offered based on cost of living, this is typically kept separate from base pay and is meant to offset short-term costs.)

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. 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, in particular housing, where there can be sharp differences in price across very small distances (like 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).

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. 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 don’t live there (and those that do often live in smaller quarters than they would otherwise). These examples are not meant to be comprehensive but are offered to illustrate that it is generally best not to mix and match cost of labor and cost of living as the interrelationship between the two can be complicated. Rather it is recommended that you use the differential that is most applicable to the analysis at hand.

The Geographic Assessor is intended to show "both sides of the story," that is, area differentials for both competitive salaries and cost of living. While using the cost of labor is recommended when adjusting salary structures, in some situations, both variables can be considered when making pay decisions (such as when dictated by union or other contracts or perhaps in some remote worker instances). It is important to note that the Geographic Assessor only reports summary cost of living differentials based on the rental housing market and benchmark assumptions for each earnings level. The Relocation Assessor was specifically designed to build relocation packages and reports rental and ownership differentials, along with itemized break-outs of the expenditure categories. While you should use the Geographic Assessor to set wage and salary levels based on geographic differentials, the Relocation Assessor is better suited to determine COLAs.

See Cost-of-Living Notes.

See Salary Structure Variances for more information.