Labor Costs Don’t Have to Send the Bull Market Packing

So some part-time American workers are finally going to get a decent pay raise, and what does Wall Street have to say?

“Oh please, no!”

“Inflation will soar!”

“This will kill our great economy!”

“It’s curtains for the bull market!”

If those weren’t exactly the lines you saw in news stories and analyses after the United Parcel Service of America strike was settled last week, that’s only because most corporate executives, economists and Wall Street investment strategists would never use such wording publicly.

But privately, they said all that and more. Which ought to rankle the heck out of most working people.

It is now conventional wisdom that inflation has been “dead” in the 1990s. What that really means, however, is that prices of goods and services, as well as wages for most people, have been rising at the slowest pace since the 1950s or early 1960s.

There has, in fact, been plenty of inflation in this decade, but it has been concentrated in three places: corporate earnings; financial assets (i.e., stock prices), and executive salaries and stock option awards.

Now the UPS settlement is being held aloft by the Teamsters union as a tremendous victory for the average American worker. But that is largely because of the wage hikes UPS agreed to give its part-time workers--7% a year, overall, for the next five years--and because UPS agreed to make more part-time positions full-time, if the company’s volume of business increases as hoped (which is no small condition, by the way).

Full-time UPS workers, by contrast, will get 3% pay raises each year for the next five years. Considering that that is approximately what the annual consumer price inflation rate has been in the 1990s, 3% doesn’t look all that shocking.

In fact, at least for 1998, that raise will lag the 3.8% average increase that nonunion hourly employees nationwide are expected to get, according to consulting firm Hewitt Associates’ annual salary survey of 1,244 employers, released last week.

Still, there is no question that UPS, with 300,000 U.S. employees (and part-timers making up an ever-growing share of that total) will face a significant increase in overall labor costs, which already amount to 60% of its annual sales. And that is raising the prospect that UPS will 1) see its profits shrink or 2) sharply boost shipping rates, in turn helping to fuel higher inflation in the economy, or 3) both.

Extrapolate any of those outcomes to the corporate world overall and you begin to understand why investors would fear for the economy and stocks’ bull market.

*

But can we--should we--extrapolate?

First, let’s remember that the UPS settlement is a symptom, not a trigger. It’s a symptom of a tight U.S. labor market that everyone already recognizes is tight, and has been for a while. “This conflict came out of the economic environment. It didn’t set the tone for it,” says Ken Goldstein, economist at the Conference Board in New York.

Manpower Inc., the temporary-help company, said last week that its quarterly employment-outlook survey of 16,000 U.S. businesses shows that a higher percentage of companies intend to hire in the fourth quarter than have done so in any fourth quarter since 1978.

In other words, what we have today is a bull market in labor to go with the bull market in stocks.

Will wage inflation, and price inflation, rise under these circumstances? Many economists naturally think so. But we are talking about gradations here--not, suddenly, a return to 6% or even 5% price inflation. More like a move from 3% to 4% over the next two years, say Goldstein and others, as companies seek more pricing “flexibility” (the old euphemism for “increases”) to accommodate higher wages.

We hear constantly that businesses can’t raise prices today because of heated competition, and that is true to a large extent. Clearly, it’s going to be tougher for many companies to show strong earnings growth if labor costs rise but prices don’t.

But will that predicament be widespread enough to kill the bull market and/or ruin the economy?

The gloom-and-doom purveyors should keep a few things in mind:

* Major pay raises increasingly are tied to performance. The Hewitt survey shows that 67% of companies now have some kind of performance-related award program in place, and those programs “have been and will continue to be key to overall earning potential for most employees,” Hewitt says.

What that means is that more workers can see a specific reward waiting for them if they help their employer meet specific targets (sales, earnings, etc.).

(UPS, incidentally, offered the union a profit-sharing plan; the Teamsters leadership rejected it without allowing the rank-and-file to vote on the idea.)

* Rather than cash wage increases, stock is increasingly the compensation of choice among employers. And because of admittedly controversial accounting rules, stock and stock option awards don’t affect companies’ bottom lines the way higher cash wages do.

In Silicon Valley, engineering jobs are hard to fill, and many such positions always have been hard to fill. Stock option awards provide the incentive that fills jobs and fuels the entrepreneurial spirit there and in much of America.

Some critics would say America has developed a “cult of equity” and that too much emphasis is placed on stock performance and stock rewards. But what better way to ensure that employees reap a significant reward for the hard work that makes their business successful?

Cult of equity? “How about the ‘triumph of reason’?” says Gordon Richards, economist at the National Assn. of Manufacturers.

* Finding new ways to boost productivity is a virtual religion among American businesses today. Nobody in this country should be worried about rising wages. The only concern is that wages would rise without rising productivity.

Although it is difficult to measure precisely, rising worker productivity certainly has been one of the major reasons why the American economy has succeeded so brilliantly in the 1990s--and why price hikes have remained muted even as profits have soared. Workers find ways to do more with less.

Will the productivity juggernaut suddenly halt? Unlikely. If anything, pressure on wages will cause companies, and workers, to redouble efforts to work more efficiently. And we must--because the rest of the world is on the same track.

* The bond market isn’t going to let inflation surge. Bond investors--or more specifically, bond traders--have been looking for signs of higher inflation under every rock. Because they have continually turned up empty-handed in this decade, they have grudgingly allowed interest rates to decline.

But imagine what will happen if wage and price pressures truly begin to build. Bond yields will soar. The Federal Reserve Board will be forced to follow the market, and tighten credit. And the economy will be forced to slow--putting further downward pressure on wages and prices, as workers feel less secure about their jobs and companies less secure about raising prices.

Curse the bond market? OK. But the market’s inflation vigilance has helped keep this 6 1/2-year-old economic expansion going--which sure beats the old boom/bust cycle.