The U.S. Unemployment Boom
Jude Wanniski
October 1, 1987

Executive Summary: Repeated predictions of U.S. recession by Keynesian doomsayers are being overtaken by cries of a new crisis, a growing "labor shortage" approaching some "flashpoint" that triggers inflation. The U.S. employment boom though, resulting from the profit opportunities opened by the Reagan tax reforms and monetary stability, is not inflationary Wage rates will rise as labor shares in productivity increases. Enterprises will forage for labor in jobless pockets, raise perquisites to attract senior citizens and more women into the labor force, continue to attract public-sector workers, and engage in international labor arbitrage until all profit opportunities have been realized. Open immigration is not a realistic antidote. The trade deficit will reverse when Europe and Asia replicate the Reagan reforms, but this will put further pressure on the labor pool, resulting in more rapid modernization and computerization of industry, plus upgrading of labor skills. Individual enterprises and managers have definite problems in adjusting to tight labor markets, but this can only mean healthy developments in a macroeconomic and social sense.

The U.S. Unemployment Boom

The best of times or the worst of times?

The U.S. economy is only a month away from setting a record of uninterrupted peacetime growth 58 months and Barbara W. Tuchman, the historian, writes in The New York Times Magazine of "A Nation in Decline?" a morose contemplation of America's "deteriorating ethic," with "incompetence and inefficiency threatening survival."

The August 10 BusinessWeek proclaims "The Coming Labor Shortage," which the September 14 Wall Street Journal ("Workers Wanted") tells us has already arrived. Yet Alfred Malabre, one of the Journal's senior editors, advises his readers September 10 that the recession he has been predicting for years may have already begun, but we do not yet realize it: "Some Signs Say a Recession of a Sort May Have Started."

Lester ("Zero Sum") Thurow has been named chairman of the Sloan School of Management at M.I.T., having for years repeatedly predicted the current economic depression that Malabre has now detected early signs of. In the Journal's Monday "Outlook" column of September 21, another eminent M.I.T. economist, Prof. Charles Kindleberger, sagely announced that in order to cure the U.S. trade deficit "we have to have a recession." The Democratic Presidential contenders, each of whom is being advised directly or indirectly by Professor Thurow, uniformly denounced the Reagan economy in a September 23 debate. They promised that if elected, they will produce "jobs, jobs and more jobs," thereby aggravating the labor shortage.

The labor shortage, in fact, is real, and unless a recession can be arranged to build up the "reserve army of unemployed," we are going to enjoy this growing pain for quite a long time.

Labor shortages can be enjoyed Dy the economy as a whole because they are not inflationary. They are simply evidence of a surplus of profit opportunities. Demand-side Keynesians are as baffled now as they were in the opposite situation a decade ago, when wage demands soared even as unemployment rolls lengthened. The New York Times of Sunday, September 20 reported "Inflation Fears Fade Even as Jobless Rate Falls:"

At 5.9 percent for the last two months, the unemployment rate has already pierced the 6 percent threshold that for a decade was judged the flashpoint of rising inflation. At that moment, the Government often tries to cool the economy by such means as raising taxes and cutting public spending or by raising interest rates....Now because of huge changes in the economy's dynamics, notably industry's difficult but ultimately successful absorption of postwar baby boomers and women, economists say that unemployment is settling back toward the low levels of two decades ago and allowing the Government more time before making it necessary to put a damper on things.

This shallow demographic reasoning is not at all what's going on. Inflation is a monetary phenomenon and has nothing to do with labor shortages. There is no Phillips Curve "flashpoint" that will trigger a burst of inflation. Unemployment could again fall to the 3 percent level we experienced without inflation in the 1950s and '60s, or that Japan has experienced with deflation in recent years! As long as President Reagan is not talked into inviting a recession by raising taxes or signing a trade bill, about the only other domestic variables that could slow the falling unemployment rate are the general level of welfare benefits and minimum wage.

The profit opportunities that now abound flow from the Reagan tax reforms and the prospect of lower interest rates associated with the G-7 groping toward monetary reform. Individuals are now able to keep far more of their production than in the pre-Reagan years, when the marginal tax rate was 70 percent, and will be able to keep even more next year when the top rate drops to 28 percent.

Examples of similar surges in new profit opportunities occur throughout history. Following the supply-side monetary and fiscal reforms of Caesar Augustus that launched the golden age of the Roman Empire, historians report that the profit opportunities in Alexandria were so great that employers were hiring and training blind men and cripples. And because it became more economical to hire labor as needed than maintain it full time, slaves were being freed at such a rapid rate that Augustus worried about weakening blood lines decreed the rates at which manumission could proceed.

Profit opportunities are merely perceptions. That is, an individual thinks he sees profits to be made if he can deliver the goods or effect the arbitrage better or sooner than others who may have the same perception. For example, a hundred people decide simultaneously to open restaurants in Cleveland, given the new higher after-tax payoff for success and the lower costs of capital. A few thousand people are involved in these enterprises, all of them paid their asking wages. Perhaps 20 of the entrepreneurs get their payoff, the others fold, older and wiser, and 80 new entrepreneurs step forward to redesign the restaurants and menus.

These several thousand jobs created -- in the restaurants and in support of the restaurants -- could not have been created if the enterprises did not think they could be filled at wages that would leave profits, given the expected level of success. The minimum wage law has no bearing on this expectation in an area where restaurants must pay above the minimum to attract help. But on the margin, there are certainly communities and parts of cities where an increase in the minimum wage would both pull down enterprises that are now hanging on and would cause planned enterprises to abort, seeing a closing of a profit opportunity. A rise in the minimum wage is unambiguously bad for employment and would thus help relieve the "labor shortage." Yet it would be ridiculous to argue, as the labor shortage theory requires, that higher minimum wage rates must by raising unemployment -- lower inflation.

Similarly, an increase in welfare benefits increases the hurdle rate out of dependency and unemployment. Individuals have to be offered higher wage rates to attract them off welfare, and on the margin individuals who are employed will become unemployed in order to live on the higher welfare benefits. Countries that combine unduly generous benefits for not working, together with punitive tax rates for working, will indeed experience chronic high unemployment. But such high unemployment certainly does not ensure low inflation of either wages or prices.

The chart compares recent unemployment rates in several countries with their so-called "wage inflation" over the past year. Clearly, many countries with depression-level unemployment rates have had far more rapid increases in nominal wage rates than countries that do not waste labor, such as Switzerland, Japan and the United States. Low unemployment does not cause high wage gains, and high unemployment does not prevent such gains (as "stagflation" demonstrates). Workers always "demand" as large a pay hike as they can get, but what they can actually get depends on the opportunity to employ them profitably. Real income per worker can only rise with increased real output per worker higher productivity of labor and capital.

Nominal wages can rise despite productivity gains, of course, but only if prices in general are rising. But prices in general can't be rising unless the supply of money exceeds the demand. Inflation in the market for goods and services naturally causes inflation in the labor market too, but wages typically follow prices, not the other way around. Generally higher prices allow generally higher wages to be paid. If the G-7 countries succeed in stabilizing exchange rates and commodity prices, there need be no inflation in either prices or wages. The employment situation in these countries will then simply mirror, as it does now, the different opportunities for making profitable use of workers at a mutually agreeable after-tax cost of labor to employers and after-tax return to workers.

We know that employers can cope with chronic "labor shortages" in non-inflationary situations, because that has been the normal situation in U.S. history, as it still is today in other countries with both low tax rates and strong currencies, such as Switzerland, Japan and Hong Kong. How, exactly, can U.S. employers also accomplish such a blatant contradiction of the Keynesian Phillips Curve?

At first, there is a pool of experienced unemployed labor that is actively seeking work. When that is depleted, the enterprise can tap the experienced labor that was not actively seeking work because the wage level was too low. The New York Times of Sunday, September 27 tells of "America's Army of Non-Workers" and identifies some 6 million who say they want work but are not seeking jobs. For the most part, these are people who have calculated that after taxes, withholding, child-care costs, transportation costs, and clothing and miscellaneous work costs, the net income is not worth the time and effort. Employers in many labor-short cities are now offering a choice of child-care or transportation extras to attract women back to the work force.

Another option to the enterprise that sees profit opportunity in a labor-short area is to advertise in a labor-surplus area. Before the deflation that began in 1981, the most publicized domestic labor migration was the flow from Michigan to Texas and Alaska, unemployed auto workers finding work in the oil fields, a migration that has reversed with hard times in the oil patch and the relative prosperity in parts of the so-called "rustbelt."

Still another option is to use some of the profit opportunity to recruit and train unskilled labor. Inner-city blacks, "the last hired and the first fired," as the saying goes, are now being reached. With a surplus labor pool, enterprises could screen out applicants who did not have "a basic standard of appearance," who used rough street language, or who could not pass English and math entry tests. Now, the choice is to drop these entry standards or forego profit opportunities. Reports abound of new corporate training programs that upgrade appearance, language and basic education, and reward such efforts.

The process takes more than a little time to unfold and it often seems like a "trickle down" effect, but if the expansion can be kept going the process will accelerate as the so-called hard-core unemployed get jobs. The vast underclass that was created by the combination of economic decline and social engineering has been out of school for years, on average, and it is a struggle to relearn. The spirit of opportunity that has taken hold can only strengthen the education process. Diplomas now mean something. Inner-city property values have already turned. The recent redevelopment of Newark is surely related to these positive developments in the labor market, which have second-order effects on the crime rate, drug use and family stability.

The wealth effects of the long expansion and stock market boom have some related influences on the labor pool. College education became more affordable to millions of families, despite the higher costs, as the value of their past savings climbed on Wall Street and in the real values of their properties. Colleges have been swamped since 1985 with unexpected admissions. The increments are from those high school graduates who would normally be the cream of the entry-level labor market. The effect is to boost current wage offers for unskilled work, as well as to increase the future pool of skilled college educated workers. The rising tide continues to lift all boats.

Another effect has been on the available pool of working mothers. New profit opportunities increase the attractiveness of matching job opportunities to mothers with children. But working against this attraction is the increased after-tax income of the working husband, enabling women to remain at home to raise children and inviting those at work to quit. Much of the increase of the work force during the stagflation of the 1970s resulted from women who had no choice but to work even if it meant a generation of "latchkey children."

A likelier source of low-skilled labor in this expansion is the pool of senior citizens, willing to take part time service McJobs as wages climb. In jobs requiring more skills, effort, or on-the-job training, such as clerical work or real estate, women with grown children will become willing to start a late career with the inducement of much lower tax rates on joint incomes. For a woman to start over at age 40 used to be prohibitive, because she would necessarily start at a relatively low wage but be taxed at the 40-50% rate of her husband. Tax reform changes all that, particularly next year. Two M.I.T. economists estimate that "labor supply of wives will increase by 2.64% under the new tax bill."1 Tax reform can make a significant dent in the "labor shortage." Indeed, unemployment might even rise with the surge of eager job seekers, were it not for the benefits of a "job shortage" that is adding well over 200,000 jobs per month.

Another effect will be to put pressure on the existing stock of government labor. When there is a labor surplus, the pressure is to expand public-sector labor, and experts are employed to develop rationales on why such jobs are needed, even, in the ridiculous extreme, Keynes' idea of hiring people to dig holes and fill them up. In the labor squeeze now developing, the reverse is true. The best people working for government will bolt to the better opportunities emerging in the private sector. Experts will provide rationales on why holes should not be dug and filled, and public-sector jobs will continue to decline as a percentage of the work force.

On a global scale this is happening to entire state-owned industries and the public-sector ("socialist") nations themselves. Privatization is underway everywhere that policies are permitting private sector growth. The best example is the United Kingdom's dramatic reforms under Margaret Thatcher, with privatization of socialized industries preceded by sharp cuts in marginal income tax rates. The September 16 Financial Times has a superb special survey on the British experience with privatization and trends in this direction around the world. It has been well underway in Mexico and elsewhere in Latin America, in the Philippines, in parts of sub-Sahara Africa. It is also well underway in China (capitalism is called socialism with Chinese characteristics), has revived in Eastern Europe, and is finally taking hold in the Soviet Union. Lenin's New Economic Policy in the 1920s was following this pattern when the Wall Street Crash, Smoot-Hawley and the Great Depression crushed private-sec tor profit opportunities everywhere. (A repeat of 1929 and the trade wars that followed would likewise see the end of Secretary Gorbachev's restructuring and glasnost, and a return of the Gang of Four in Peking.)

All of these pressures are very healthy, which is why we should enjoy the labor "shortage" rather than bemoan it. The only other way to relieve it would be through the traditional method of liberal immigration. In the 19th century and much of the 20th, the Eastern commercial establishment was forced to support free immigration to assure a steady supply of cheap labor. The open Western frontier and cheap land kept upward pressure on the wage rate, immigration kept it down. When the cheap western lands were finally gone, sealed off as government parks and wilderness, the commercial establishment's support of open immigration waned.

The 1986 Simpson-Mazzoli law is already being blamed for the palpable tightness in the labor market, and pressures are building for liberalization. The Times front page of September 25 reported "Chinese-American Concern Ready to Bring Peasant Workers to U.S." under a new program established by the '86 immigration law.

It really isn't reasonable to expect immigration to solve this problem. The reason for the labor squeeze is the perception of profit opportunities brought by tax reform and monetary stability. As I've observed before, in the reductio ad absurdum, with limitless profit opportunities in the United States and none elsewhere, the migration of human and financial capital to the U.S. would continue until everyone lived in the U.S. In this light, open borders in a land of opportunity are a good thing, but the safety valve they provide to foreign nations reduces pressure for healthy economic reforms abroad.

Absent the kind of immigration flood that would satisfy labor demand here at the entry level, the profit opportunities in the U.S. would still make use of foreign labor. Labor is arbitraged across borders just as capital is. Enterprises in the U.S. hire widget workers to make goods or provide services that have higher returns than widgets provide, and simply buy the widgets from foreign producers. The foreign widget producers use the dollars acquired to buy either U.S. goods or services or other countries' goods or services or domestic goods, with someone prepared to use part of the proceeds to buy U.S. financial assets. In effect, they are sharing in the profit opportunity that opened up in the U.S.

This labor arbitrage is thus the source of the U.S. trade deficit. It will stabilize when all the U.S. profit opportunities flowing from the Reagan reforms are realized: The world economy will be at a new equilibrium. If the rest of the world adopted the U.S. reforms, labor arbitrage would reverse, resulting in a U.S. trade surplus. As an incipient worldwide "labor shortage" developed in these circumstances, the solution would be an expansion of U.S. capital, the rapid modernization and computerization of plant and equipment, and the valuing up of labor. McDonald's would still be around, but offering McCaviar and Eggs McBenedict.

This scenario is waiting on West Germany and Japan taking the lead on tax reforms, forcing replication on their trading partners in Europe and Asia. It also awaits reforms of the international financial institutions, still dragging their feet on the Third World debt problem. Instead of trying to raise taxes in the creditor nations in order to bail out the big banks, tax rates should be slashed throughout the debtor regions. These breakthroughs do not seem imminent, but there are some hopeful signs.

In any event, the "labor shortage" that is coming or that has already arrived is a good thing and should be enjoyed in a macroeconomic sense. In no way can it be inflationary. As Margaret Bush Wilson of the NAACP put it a decade ago, "Inflation is not caused by too many people working." Wall Street economists like Bear Stearns' Lawrence Kudlow may be alarmed that there are too many jobs out there. Academic economists like Northeastern University's Barry Bluestone may be alarmed that there are too many low-paying jobs that people won't take that are out there. But like M.I.T.'s Lester Thurow and The Wall Street Journal's Alfred Malabre, they are part of the chorus that has been predicting for years that we would soon be drowning in a sea of joblessness. The crisis, instead, is a sea of jobs, one that's going to be around for quite a while.

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1 Jerry A. Hausman & James M. Poterba, "Household Behavior and the Tax Reform Act of 1986" NBER Working Paper No. 2120 (January 1987).