Reality Sets In: Life in the Economic Fast Lane May Be Over

Earlier this year, John P. LaWare visited his old stamping grounds in Boston, where economic gloom is thicker than a March fog on Boston Harbor.

LaWare, who left his job as chairman of Shawmut Bank two years ago to become a member of the Federal Reserve Board, gently chided some of his friends for having lost their perspective.

“I know most of you have had the sometimes hair-raising experience of driving on the Mass Pike,” he said in a speech to the Chamber of Commerce. “Although the posted speed limit is 55, most of the traffic whirs along at 65 to 70. After you have been traveling with the crowd, well over the limit, if you have to slow down to 55, you have the feeling you are just crawling along. Travel in the fast lane is exhilarating, and when you have to slow down there is a sense of disappointment and frustration.”

In Massachusetts and other parts of the Northeast there is plenty of disappointment and frustration with a regional economy that clearly is lagging after years in which, as LaWare put it, “we were on a roll, and it didn’t look like it would ever stop.”

That same sense of moving out of the fast lane is hardly confined to the Northeast. It has hit Washington and some other metropolitan areas, and in a way, the United States as a whole.

Booms have not turned to busts, either locally or nationally. Even in Massachusetts the unemployment rate has only risen to match the national average of 5.3%. Rather, what has happened is that some key ingredients for rapid growth, especially unemployed labor, have disappeared.

Nationally, after six years of expansion during which unemployment was cut in half, economic growth has slowed enough that the jobless rate has been virtually unchanged for nearly a year and a half.

Like it or not, such a slowdown was inevitable at some point. Just like highways, economies have speed limits, and they cannot readily be changed by governments.

As the president’s Council of Economic Advisers put it in its annual report last month, “The nation’s productive capacity depends on the level of technology, the supply and quality of capital, and the number and skills of workers.”

After recessions, stepped-up use of readily available labor and capital--unemployed workers and shuttered factories--translates quickly into growth in the output of goods and services. “As in most economic expansions, much of the relatively rapid growth since the recovery began in 1982 can be attributed to increases in the employment and utilization of existing resources.” the report said.

In many parts of the country, the extended expansion created a sense that such fast growth was “normal” and raised expectations to unrealistic levels. With relatively few idle workers, factories or machines in the United States today, the CEA cautioned that “fewer opportunities to increase utilization of available resources remain.”

CEA Chairman Michael J. Boskin and his two colleagues project in their report that productivity gains--increases in the goods and services produced during each hour worked--will become a more important source of economic growth than increases in the size of the labor force during the 1990s. That would be a reversal from the past two decades.

Even though the Bush CEA is somewhat less cautious about the risk of higher inflation than a number of other economists and policy-makers, including most of those at the Federal Reserve, the report’s long-term economic projections indicate that the council does not think that the unemployment rate should be pushed below 5%. Doing so could spur faster growth in wages and benefits, which would lead to higher inflation.

If faster growth added to the demand for labor only in states such as Michigan, Louisiana and West Virginia, all of which have unemployment rates of 7% or more, perhaps the national rate could be lowered without putting added pressure on wages in those areas in which unemployment was average or below.

To some extent, market forces work in that direction as employers seeking to expand or reduce costs shift operations to areas in which labor is more plentiful. But there is little that any government policy can do to encourage job creation in a particular spot--except by making choices for where it spends its own money, such as for military bases or the planned $8-billion superconducting supercollider slated for Texas. Certainly the Federal Reserve does not know how to do it.

At a hearing recently, Rep. Olympia Snowe, D-Maine, sought some words of reassurance from Fed Chairman Alan Greenspan about the problems in her state and region. “Do you look at the regions in determining our monetary policy, or do you think it’s just unique to that particularly region?” she asked.

Replied Greenspan, “Unfortunately, our monetary policy can only be national because we are dealing with a national interest rate, a national currency and basically national prices.”

Snowe described the results of the shock from dashed expectations. In Maine, she said, “people are retrenching in terms of their spending. I mean they just lack the confidence.

“Even though they have a job and the unemployment rate hasn’t increased significantly to indicate that there is something seriously wrong in that area, people are nevertheless hesitant about spending because of the decline in the value of real estate and whatever else has happened.”

This confrontation with reality became inescapable when the Northeast effectively ran out of available labor. In coming years, economists studying regional patterns believe, above-average growth will come in states in the South and West, where labor will be available because of relatively high population gains.

When labor markets get tighter than average, wages tend to rise faster than average. At least that has been true in the Northeast, according to the Labor Department’s employment cost index.

More detailed estimates for individual metropolitan areas by regional economists at Data Resources Inc. showed that the seven cities with the largest increases were all in the Northeast. Figures for the seven ranged from 8% in Newark to 9.2% in Bridgeport, Conn., compared with a national average of 5.6%.

Nor did this just begin last year. With labor markets so tight, compensation has been rising more rapidly in the Northeast than nationally for some time, and that is one of the major reasons economic growth has slowed sharply.

If companies know the only way to find workers is to raise pay high enough to take them away from other employers, they think twice about expanding.

But the impact of tight labor markets and rapid wage increases doesn’t stop there. With more money to spend, buyers have been able to bid up the price of goods and services not set in national markets, especially the price of housing.

The natural reaction of developers and lenders was to flood these booming markets with expensive new single-family homes, condominiums and vacation houses. A large amount of new commercial office space was built, too.

As fast as incomes were rising, however, they were not doubling in three years, as house prices did in some areas. At some point, home prices had to stop rising so fast, and they finally did so abruptly last year.

Now thousands of new condominiums stand unsold, some developers are out of business and several major lenders--most prominently the Bank of New England, which lost $1.11 billion in 1989--have a lot of nonperforming loans on their books.

In the face of all the unsold homes and unoccupied offices, new construction, a major source of growth, has been slashed drastically and is now a drag on the economy.

Other such cyclical forces are at work in the American economy, too. Manufacturing firms have spent considerable money modernizing their plants in the past couple of years. In industries such as paper and chemicals that ran short of production capacity at the end of 1988, part of the capital spending has increased capacity as well as efficiency. Now most forecasters expect smaller increases in investment.

Even the dollar is doing its part, rising in value compared with several key foreign currencies and making U.S. goods more expensive in other countries. This leads economists to expect smaller increases in exports this year--another development that will tend to hold down economic growth.

But the key question not just for 1990 but the rest of the decade is what resources the nation will have available to put into the growth pot. For example, every American who will enter the labor force during the 1990s has already been born.

An unknown number of immigrants will swell that total but not change the essential picture, which is one of slower labor force growth than during the 1970s or 1980s.

The CEA noted in its report that “many observers now worry about the availability of workers--especially skilled workers. Some have even argued that labor shortages will dominate the 1990s and may slow economic growth.”

Boskin and his colleagues nevertheless are optimistic that market forces will mitigate some of the impact from slower growth of the work force.

“Those who argue that labor shortages will stall the economy in the next decade ignore the flexibility and adaptability of U.S. firms, workers and governments,” they said.

Stalling the economy is not necessarily the issue, however. The U.S. labor force is likely to grow only about 1.3% a year in the first half of this decade and production of goods and services by those added workers will raise national output.

But increases in the work force averaging 1.3% will be lower than the 1.7% rate of most of the 1980s and lower still than the 2.4% annual increase between 1973 and 1981.

The civilian labor force stood at 124.4 million at the beginning of this year. Therefore, a 1.3% annual increase would mean about 1.6 million more workers a year. Providing employment for those additional workers would require roughly 135,000 new jobs per month.

Those figures are not understood in some quarters. For example, when the monthly figures on payroll employment hit the news, financial market analysts routinely describe anything less than a gain of 175,000 to 200,000 as evidence of significant economic weakness.

Like all those residents of the Northeast with unreasonable expectations about what is “normal” growth, some analysts seem to have an exaggerated sense of how fast the labor force and thus the overall economy is likely to grow.

A few, such as Richard Rahn, chief economist at the U.S. Chamber of Commerce, understand the numbers but believe the economy still has plenty of room to expand because they think the unemployment rate could fall to 4% and perhaps to 3% without causing inflation to worsen.

Rahn argues that if the Federal Reserve pursued a steady, predictable policy of money growth and the unemployment rate fell slowly over a period of years, inflation problems would be avoided.

But that is a minority opinion. “When you’ve used up your unused resources to a degree that you see inflation creeping up, as I think was the case in 1988 and 1989, you have to shift the burden of risk and be more concerned about inflation,” declared Marvin Kosters of the American Enterprise Institute in Washington.

“The good news today is continuing growth but moderate growth. It would not be good news to see growth rates shoot up. Then policy would have to turn more restrictive,” probably pushing the economy into a recession, Kosters said.

Kosters’ view is widely held, and certainly is the basis of the Fed policy that shifted in the spring of 1988 to seeking to slow economic growth to head off a surge in inflation.