Labor Markets in the New Economy
Nothing wrong with insurance. That's what Federal Reserve Chairman Alan Greenspan took out when he raised short-term interest rates 25 basis points, bringing them back to their pre-1998 Asian financial crisis levels. After all, economic growth is surging ahead at a blistering 4% annually, for the fourth year in a row. Probably too fast. What's troublesome about the tightening move is its justification--what the Fed described as the inevitable inflationary consequences of a shrinking pool of available workers--and the echoes that has with past economic orthodoxy. The Fed is using certain measures of labor availability to determine the speed limit of growth. But like so many other factors in the New Economy, it may be those measures are no longer reliable.
The shape of the U.S. economy is changing so quickly that no one really knows what its contours are anymore. Recent revisions in the government's productivity statistics show that the official view of the economy is just beginning to catch up with reality. There are things we now know about the New Economy and things that remain a mystery.
The revised growth and productivity numbers tell us that in contrast to conventional wisdom, a New Economy of accelerating productivity growth actually began to develop in the early 1980s, just about the time that the personal computer revolution took hold. Average productivity growth accelerated in the 1990s and hit a rate of 2.5% annually beginning in 1995, around the time people first began plugging into the Internet. It turns out that the long bull market in stocks, based on strong corporate profits, has been the best indicator of the gains in productivity all along.
But what we don't know about the New Economy is still enormous. We don't know how fast the economy can grow without inflation. If the strong productivity gains of the late '90s continues, then the economy can grow at 3.5%, just a tad lower than today's rate. If productivity weakens, then a 3% annual growth rate is more appropriate.
We also don't know why wage gains have remained remarkably modest in such an extremely tight labor market. Waiting for wage inflation has become as endless as waiting for the stock market bubble to burst. Conventional wisdom suggests that wage inflation should be soaring with unemployment so low and the economy so hot. It isn't.
Why not? One reason may be that the U.S. now has an economy split between the Old and the New. While the growth in real wages has been rising sharply in New Economy industries, such as software, they have been stagnating (or even falling) in many Old Economy sectors, such as food stores. Productivity gains have been much higher in the New Economy, allowing for wage gains without inflation.
We also don't know if globalization has, in effect, increased America's overall labor pool, curbing wage gains. In both high-tech and low-tech industries, immigration plays a greater role in supplying labor and driving growth. Capital and work are both more mobile, as corporations shuffle jobs among many countries around the world.
Bottom line, the Federal Reserve justified raising rates by saying "the pool of available workers willing to take jobs has been drawn down further in recent months, a trend that must eventually be contained if inflationary imbalances are to remain in check and economic expansion continue." In fact, the New Economy has yet to reveal exact safe speed limits for economic growth. So far, the Fed has been remarkably open to the idea that the New Economy has changed the rules of the game. And that could just as easily be true for labor markets as it was for productivity.