Commentary: False Alarm On Wages. Someone Go Tell The Fed

The pressure on the Federal Reserve Board to raise interest rates eased recently, after the Labor Dept. said that consumer prices edged up a mere 0.1% in August. Still, Wall Street bond hawks worry that spreading labor shortages are driving up wages, which could spark inflation six months to a year from now. So some still are pushing for a small rate hike when the Fed meets on Sept. 24.

The Fed should stick with a wait-and-see posture. True, pay rates have jumped this year. So have unit labor costs, which take into account the 1% gain in productivity for January through June. But the worrywarts ignore the plunge in corporate spending on benefits, which leaves the total labor bill almost flat this year, after adjusting for inflation. What's more, there's reason to believe that the runup in unit labor costs is a statistical quirk that could be revised downward. "Wage increases in the past year have been small, and they've been more than offset by productivity gains," argues Jerry Jasinowski, president of the National Association of Manufacturers, which wants the Fed to keep rates low.

Even if Jasinowski is wrong, there's no reason to slam on the monetary brakes anytime soon. After all, employers enjoyed four years of flat or falling unit labor costs at the beginning of the current recovery, when pay and benefits lagged behind productivity growth. So they have room to absorb a year or two of higher labor expenses without driving up prices. True, profits might slip slightly if that happened, which the stock market wouldn't like. But given today's stiff global competition, companies wouldn't be able to pass along higher costs to consumers in any case. "Because of today's more competitive business environment, higher wages would likely erode profits slightly rather than raise prices," says Harvard University's Dale W. Jorgenson.

Wall Street's concern stems from Bureau of Labor Statistics (BLS) wage figures. Its Employment Cost Index (ECI) shows that pay rose at a 3.4% annual rate through June, the latest period available, or about half a percentage point higher than inflation. But cost-control efforts such as managed care have cut benefits growth in half, to less than 2% a year. Result: Inflation-adjusted total labor costs rose a mere 0.1% in the 12 months ended in June (chart).

The bond market has been fretting about BLS stats on unit labor costs, too. They show labor expenses per unit of output exceeding inflation by nearly one percentage point in the past 18 months. Problem is, these figures use a wage-and-benefit survey that is notoriously unreliable. Many labor economists prefer the more comprehensive ECI. Using that measure, the labor-cost spike is likely to disappear as more data comes in. "The unit labor cost increases this year will probably be revised down," says David S. Wyss, an economist at DRI/McGraw-Hill.

"NO WAGE PUSH." Either way, there's little evidence that employers face severe wage pressure yet. For four years after the recovery began, companies enjoyed climbing productivity and flat or falling total labor costs. This is a key reason why profits have soared in recent years. Today, in the worst-case projection, tight labor markets may force employers to dish out a little more for labor than before. But they're still producing more per dollar spent on an hour of labor than they were in 1991. Maybe not quite as much more as a year ago, but still more. "Companies are still producing more per worker and only paying workers a little more," says Harvard labor economist Richard Freeman. "There's no wage push inflation right now."


So companies can swallow slightly higher costs and still be ahead of the game. What's more, an uptick in labor expenses does not threaten U.S. companies' international standing. Unit labor costs among U.S. manufacturing companies have inched up at a mere 0.3% a year since 1990, while those of our eight largest trading partners have risen by 3.2%, according to a recent BLS analysis.

There's not much doubt that labor shortages have finally started to push up wages this year. But the Fed needn't be alarmed unless these gains accelerate or benefit costs rebound. Until either occurs, the economy should be able to grow at its current pace and still keep inflation in check.

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