The tight labor myth

Pundits were split last month on whether the Fed would raise interest rates for the third time this year, variously forecasting the cliffhanger decision based on current economic indicators and the size of Alan Greenspan's briefcase. When the Fed voted for another rate hike, analysts took their cue and came to consensus: In hindsight, since labor was tight, a rate hike had been predictable.

The increase is now a fait accompli, but it may not have been necessitated by tight labor, because the labor market may not be as tight as it looks.

No one suggests tight labor isn't a real phenomenon of legitimate concern. Based on government calculations, unemployment is at historic lows of 4.1 percent nationally, and as low as 2 percent in many American cities.

Daily media coverage tells of employers scrambling to fill openings for everything from high-tech workers to bus drivers, reinforcing the notion that labor is tight and we ought to worry about it. Wall Street is skittish when it comes to too tight a labor market, fearing a productivity plateau and a resulting wage-price spiral.

But how tight is too tight? Before the current expansion, conventional wisdom held inflation would result when the unemployment rate dipped below 6 percent. We haven't seen 6 percent in a long time, and still our high-growth, low-unemployment, negligible-inflation economy has defied conventional wisdom for years.

Why then hasn't inflation kicked in yet? Analysts typically cite increased productivity brought about by technology as the chief reason. Some wise heads point to manageable pressures on worldwide commodity prices plus cheap imports.

However, a growing number of economists and policymakers firmly believe that there is another fundamental cause: namely, we have not yet come close to employing all Americans who would like to have a job.

Just as in World War II, there is now a large pool of untapped and largely uncounted potential workers: 40 percent of women, 88 percent of seniors, large numbers of minorities, legal immigrants, able people with disabilities. As in the "Rosie the Riveter" years of World War II, productivity has been growing - and could keep growing - as more of these workers enter the labor force. Indeed, then as now, the success of employers scrambling for workers depends in part on their ability to tap into hitherto untapped human resources.

Some analysts at the Bureau of Labor Statistics say the common assessment of the size of the shrinking reserve labor pool is too conservative. The BLS makes a distinction between the official 4.1 percent unemployment rate (the rate of those unemployed officially considered a part of the existing 5.75 million workforce) and the unemployed portion of the entire cohort of Americans ages 16 to 64 (9.85 million). In fact, some noted economists such as William Baumol and Richard Zeckhauser say the actual number could be many times that - perhaps tens of millions.

Seniors are a key component of that population. Over the last 45 years, the proportion of working men over 65 fell from 65 percent to 12 percent and the median retirement age dropped from 66.9 to 62.1 - despite their being longer-lived, healthier, wealthier, and much better educated than a generation ago.

But polls show most retirees 75 and younger now believe retirement was a mistake. Since 1990 the number of seniors in the workforce began to rebound.

Those who kept working found they enjoyed better health. A 1996 North Carolina study shows that a one-percentage-point increase in employment of those over 65 led to a 7.29 percent drop in days of hospitalization in that age group. This year, despite the burgeoning senior population, the first-ever drop in Medicaid spending was posted, due in part to fewer than predicted hospitalizations.

If the nascent trend toward employing seniors, minorities, people with disabilities, and others now on the sidelines of the labor force continues, this could be the shape of things to come.

As employment goes up and more Americans enter the workforce, social costs of everything from health care to law enforcement go down. That, in turn, reinforces productivity, feeding a virtuous circle of strong demand for labor, low unemployment, high productivity, and high growth with low inflation.

The lesson of the tight labor economy is that we need to make more extensive use of the real reserve labor pool if we want sustained, robust expansion.

Markets across the US are still thriving, notwithstanding unemployment rates of 2 percent or even lower. Instead of tamping down the economy out of fear of higher employment rates, federal policymakers can do more to protect growth and guard against inflation by embracing it.

To take greater advantage of the real reserve labor pool, we need policies that remove barriers to entering the workforce. Congress took a powerful first step in voting for legislation that allows the disabled to work without losing their benefits.

We also need to cut taxes that discourage seniors and others who want to work, and make education and training more readily available for the disadvantaged.

Some will argue the government has no business meddling in the longest economic expansion in history. But from its current tax policies to the Fed's stance on interest rates, government meddling is a fact of economic life. This is one juncture in history where small shifts in the settings of economic policy levers can yield large gains in labor supply and productivity. Policymakers have an opportunity to get behind the trend toward higher employment and ride it to continued expansion and the lasting benefit of all Americans.

*Eugene Ludwig, former US Comptroller of the Currency, is vice chair of Deutsche Bank-Bankers Trust. He is on the executive council of Get America Working!, a Washington-based nonprofit advocating fuller employment policies.

(c) Copyright 1999. The Christian Science Publishing Society