Big Rethink on Levels of Joblessness

Startled by strikingly good news on unemployment and inflation, many experts are rethinking basic assumptions about the American economy and are concluding that the nation no longer needs to tolerate as much joblessness as it has for the last several decades.

The reevaluation has been inspired by the recent performance of the economy, which analysts consider the best blend of low unemployment and low price increases since the 1960s.

Economists still hew to the longtime notion that low unemployment eventually pushes up wages and, in turn, that drives up inflation. But more and more academic experts and even some Wall Street analysts are concluding that the link is looser than previously believed.

For the American public, the changes in the workings of the economy mean “we have a real opportunity. We can employ many more people without causing the rate of inflation to accelerate,” said Harvard labor economist James Medoff. “The labor market today is really where it was back in the 1960s.”

Analysts say the shifts in the economy also could have other implications over the long run. Among other things, the changes could foreshadow faster economic growth and better increases in real, or after-inflation, wages. In addition, the new relationship between unemployment and inflation could ease the way for lower interest rates, which would reduce debt-service payments for federal, state and local governments as well as for companies and consumers.

Over the short run, though, experts generally expect the nation’s unemployment rate to bounce back up somewhat. One of the main reasons: Despite the pleas of increasing numbers of academic economists to let the low unemployment “experiment” continue, skeptical Federal Reserve Board policymakers are expected to push up interest rates soon to cool off the economy and thus head off inflation. The move is likely to come either at the Fed’s next rate-policy meeting, scheduled for Tuesday, or shortly after the November elections.

Merrill Lynch & Co. economist Bruce Steinberg said he doesn’t believe Fed policymakers need to boost interest rates next week, “but I think they will.”

All the same, many economists say the tie between unemployment and inflation has shifted for two major reasons.

One is the widespread inability of workers to demand significantly higher wages even when unemployment is low, because of factors such as the weakness of unions and a relative shortage of other attractive job opportunities. A second key reason is the frequent inability of employers, even when they are forced to pay higher wages, to pass along those increased costs without losing needed customers. Instead, many of these employers, facing intensified business competition, are absorbing the higher labor costs and netting lower profits.

As a result, analysts in the last year have lowered their estimates of the lowest jobless rate that is sustainable without causing the economy to overheat or triggering accelerated inflation.

Before joblessness dropped below 6% in September 1994, 6% or a level somewhat higher was widely considered to be the “lowest sustainable” or “natural” rate of unemployment. Now, after witnessing the continued low inflation since 1994, some economists say the sustainable rate may be about 5.5% or even as low as 5%. So far this year, the nation’s jobless rate has averaged just under 5.5%, down from 5.6% for 1995.

The latest economic figures have “changed my view somewhat. Maybe we can do a little better nowadays,” said Marvin Kosters, director of economic policy studies at the conservative American Enterprise Institute think tank.

If the current pattern continues, “it’ll be seen as a turning point in our understanding of how the labor market works,” said Daniel J.B. Mitchell, a UCLA labor economist.

Still, skeptics abound.

Roger Brinner, chief economist at the DRI/McGraw-Hill consulting firm, concedes that low unemployment hasn’t yet translated into significantly higher prices. But, he said, the reason is mainly that business slumps in Europe and Japan have made it tougher for American producers to impose price increases on customers. “The old rules are still working,” Brinner said.

Brinner and many other business economists believe the Fed needs to act now to keep inflation in check. Otherwise, they fear, rapidly rising prices could throw the economy off track, chilling investment and throwing the nation into recession.

To other economists, though, the capacity of the economy to absorb low unemployment was underscored by two government reports in the last two weeks showing U.S. joblessness sinking to 5.1% in August as inflation remained tame, still up only 2.9% in the last 12 months.

“U.S. economic performance remains almost too good to be believed,” wrote Merrill Lynch’s Steinberg in a new report. “The economy continues to grow, and the unemployment rate is near a 23-year low.”

Meanwhile, Steinberg said, inflation is essentially absent, despite signs of increased wages in recent months. Inflation rates have remained about 3% or lower since 1991, the lowest levels since prices rose only 1.9% in 1965.

Analysts who support the idea that the sustainable rate of unemployment has been pushed downward cite numerous reasons why reduced joblessness no longer pushes up wages as much as it did as recently as in the 1980s.

Audrey Freedman, a New York labor economist, points to the decline of union “pattern bargaining.” For example, with the diminished power of organized labor, national union contracts no longer exert the influence they did two decades ago on overall wages.

Freedman, who has argued for more than two years that the nation’s sustainable rate of unemployment has fallen, also cites the impact of the widespread restructuring among American employers and changing employment relationships.

She noted that traditional career progressions through middle-management ranks have been curtailed, removing opportunities for pay raises.

Also, Freedman said, since lifetime careers are less common, workers frequently “reenter the competitive labor market looking for new jobs,” and when they do, they are “re-priced” by their new employers.

David H. Hendon, manager of the federally funded Verdugo Jobs & Assessment Center in Burbank, said many of the laid-off aerospace workers placed into new jobs by his agency--even skilled workers--take substantial pay cuts in their new jobs.

“General machinists who made $16 to $20 an hour in aerospace usually can’t count on anything more than $14 today,” Hendon said. “Companies can offer less to get people in, because there’s other people just waiting to get in,” he added.

Likewise, Harvard’s Medoff, coauthor of a new book arguing that the Fed should encourage lower unemployment rates, said that given all of the news about corporate downsizings, workers “are scared that they could be next.” So, he said, “you’re not very likely to be aggressive in your wage demands.”

Yale University economist William Nordhaus added that firms in the 1990s don’t appear to be as willing as in past decades to recruit workers away from other companies by offering higher wages. “They’re more cautious about hiring,” he said, attributing the trend to the costs of benefits and antidiscrimination and plant-closing laws.

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Employment History

U.S. employment this year is running just below 5.5%, which is the lowest annual rate since 1989 and the second-best rate since 1973, when joblessness was 4.9%. A look at the average annual unemployment rate:

1996 average: 5.5%

Source: Bureau of Labor Statistics