Inflation Held Likely as Labor Costs Increase

After years of modest growth, U.S. labor costs have shown recent signs of starting to accelerate, prompting new concerns that inflation is building within the economy.

The cost increases--at a time of high employment, rising commodity prices and unusually busy factories--are a reason that the Federal Reserve Board sought to slow down the economy by hiking a key interest rate earlier this month, analysts said.

Despite the Fed’s efforts, however, many economists believe that consumer prices have begun an upward drift that will be increasingly felt in the coming months.

“The concern here is that the pressures on the economy--the labor market, materials costs, etc.--will lead to a more rapid increase in inflation shortly,” said Harold C. Nathan, an economist at Wells Fargo Bank in San Francisco who foresees inflation moving from its previous 4% range to more than 5% next year.

By various measures, the nation’s economic engine has been humming briskly: Unemployment hovers just above 5%, the lowest level in years; factories in certain industries are straining nearly full time, and demand for industrial materials, such as fuel and chemicals, is high.

Together, these factors are exerting pressure on business costs and raise the specter of consumer price increases. Analysts are paying special attention to the recent growth in labor costs, a turnaround from the moderating pattern that prevailed earlier in the 1980s, said Bureau of Labor Statistics economist Al Schwenk.

For example, the BLS gauge of wage and benefit costs rose from an annual rate of 3.3% in 1987 to a rate of 4.5% for the year ending in June, reflecting higher health insurance costs, Social Security taxes and wages. Similarly, the government’s index of hourly earnings jumped to a 3.4% growth rate during the first half of this year, after rising at rates of only 2.4% for both 1986 and 1987.

“You are beginning to see wages creeping up to a level that one might find disquieting--but you’re just beginning to see it,” said Norman E. Mains, chief economist with the Bateman Eichler, Hill Richards investment firm in Los Angeles.

The question faced by policy-makers is whether creeping wages and other costs threaten to break into galloping inflation. The Fed’s recent decision to raise the discount rate--an interest rate it charges to member banks--followed an unusual debate within the Federal Reserve System over present dangers of inflation.

Some Resist Action

Some Fed officials resisted the move, because higher interest rates could threaten the U.S. economy’s lengthy expansion and because a downturn would be particularly disturbing to Republicans in a presidential election year. Moreover, higher rates could strengthen the dollar on international currency markets, forcing up U.S. export prices and exacerbating America’s trade woes.

But various officials within the Federal Reserve System argued that the danger of surging prices outweighed the other considerations.

“The Fed has signaled its intentions to prevent inflation from accelerating, and it has backed up those intentions with action,” maintained Mickey D. Levy, chief economist at Fidelity Bank in Philadelphia.

Part of the economic debate is over the question of unemployment; some experts counsel that it has fallen so low that it could trigger inflationary labor shortages, as wages escalate for sought-after workers.

Trouble Filling Jobs

For years, many fast-food restaurants and retail shops in affluent areas have had trouble filling their quota of minimum-wage employees. But now, different sorts of firms are experiencing trouble filling their ranks. To cite one example: Certain kinds of blue-collar workers, such as tool and die makers, are enjoying the strongest demand for their skills in decades.

Douglas Aircraft, for instance, sometimes flies recruits to its home office in Long Beach for interviews, an effort that has not been necessary since the 1960s, spokesman David Eastman said.

“It’s not something we usually do for hourly employees,” he explained, adding that the company has “been going everywhere to recruit--Buffalo, N.Y.; Columbus, Ohio--any place we think there is a pool of tooling people and not enough work for them.”

Katherine Tanelian, a personnel executive at Hewlett-Packard, said the high-tech firm has had some difficulty finding computer scientists, electrical engineers and some other employees with advanced technical skills.

Nonetheless, “It doesn’t seem to me as though there’s really a dramatic shift” in the labor market, she said.

Inflation Gathering Steam

While the labor pressures seem to vary among companies and regions, inflation seems to be gathering steam from various other sources as well.

The consumer price index has risen from an annual rate of 4.2% during the last three months of 1987 to an annual rate approaching 5% between April and June of this year.

“We’re doing a little bit worse in some areas and a little bit better in others,” said Daniel T. Van Dyke, head of U.S. economic forecasting for the Bank of America in San Francisco. “Overall, it looks like we’re getting a slight uptick in consumer prices.”

Those who argue that today’s inflation could prove to be more than an uptick point to several worrisome indicators besides rising labor costs.

Among them are recent price spurts for commodities and industrial materials, hikes that ultimately may be passed on to consumers. Earlier this month, for example, the Labor Department reported that wholesale prices were rising at a 5.7% annual rate.

And certain categories of goods rose even faster. These included certain “non-durable” manufacturing materials, such as plastic resins and rubber products, which jumped at a 10.8% annual rate in July, and certain longer-lasting materials, such as steel and copper, which moved up at a 12.4% rate.

“All these are what we’re concerned about,” said Craig Howell, an economist with the Labor Department.

This year’s drought in the nation’s prime agricultural areas also is expected to push up prices. According to an analysis by the investment firm of Merrill Lynch & Co., grocery prices may rise as much as 7% by the end of the year. This could be reflected in up to a one-half-point rise in consumer inflation, said Catherine McDonough, a senior economist at the firm.

Economists are also closely watching unusually high operating rates at factories, a condition that could lead to product shortages, bottlenecks and higher prices.

Earlier last week, the Fed reported that factories, mines and utilities were running at 83.5% of capacity, the fourth consecutive monthly increase and the highest rate measured in more than eight years. Paper, textiles and chemicals are among the industries working extra hard to meet the high demand for their products.

Worrisome Warning Sign

Of these warning signs, however, some analysts point to labor costs as potentially the most worrisome.

McDonough, for example, said she expects wage costs to continue upward, at least for several months, “And as they do, we’ll see more and more inflationary pressures reflected in the consumer price index.”

But others maintain that the cost rise may be more of a temporary spurt than a long-term problem, if the Fed retains its current anti-inflation stance.

Higher labor costs are “much more important to the inflation process than a temporary jump in food prices,” maintained the Fidelity Bank’s Levy. “That is what is so important to the Federal Reserve,” he said.

Some economists, meanwhile, argue that competitive realities will serve to suppress consumer prices more than is generally recognized within their own profession. They point out, among other things, that the labor movement has less leverage over wages than it used to and that productivity gains will offset at least some of the labor cost increases.

Economist A. Gary Shilling wrote in a new report, for example, that unless inflation triggers a wage-price spiral, it is not going to become a major problem. “So far, we see no strong evidence of this developing,” he said.

Norman Robertson, chief economist at Mellon Bank in Pittsburgh, agreed: “I think inflation is heating up a little, but it would be wrong to conclude that we’re returning to the environment of the late 1970s.”