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Jewish World Review Dec. 16, 1999 /7 Teves, 5760

Lawrence Kudlow

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When Alan Greenspan sneezes, Wall Street economists catch cold -- THE FED CHAIRMAN'S recent musings on the "diminishing pool of available labor" -- which Wayne Angell and John Ryding have linked to Karl Marx's Reserve Army of Labor (necessary to sustain capitalism) -- have spawned an analytical cottage industry tracking movements in the so-called pool of available workers as a leading inflation indicator.

But I have two big problems with this whole line of reasoning. First, inflation is monetary-induced, not wage-driven.

Across-the-board price hikes -- be they from wages, services, commodities, rents, interest rates, or whatever, are only possible when the Fed creates excess money that reduces the dollar's buying power. Inflation is caused by too much money chasing too few goods, not too many people working, producing and prospering.

My second problem with Mr. Greenspan's modernized Marxism is that a careful examination of the jobs data suggests that the so-called labor supply scarcity theory is bogus.

If there were a true labor supply shortage, then wage growth should be increasing. Big time. But the data suggest that wage growth is slowing, not accelerating. So the reserve army must be sufficient, not scarce.

This suggests a different labor market analysis: softening labor demand is slowing employment growth. Mr. Greenspan and his merry band of Pavlovian bond-traders should be happy. At the margin, fewer people are working, producing and prospering.

Let's look at some facts. Total nonfarm payroll growth has slowed to 2.1% over the past twelve months from a 2.9% rate in early 1998. By sector, the same story unfolds.

( Job growth in services has slipped to 3.9% in November from a 4.8% peak in late 1997.

( Payroll increases in FIRE (finance, insurance, real estate) have dropped to 2.1% recently from 4.5% in mid-'98.

( Manufacturing jobs peaked in early 1998 at a 1.7% growth, but after a 261,000 loss are lately dropping at a 1.6% rate.

( Despite strong holiday sales on-line and on land, retail trade payroll growth is down slightly from 2.5% last summer to 1.9% in November.

Now, along with low inflation expectations, slower employment gains provide a better explanation of lagging wage growth than labor supply shortages. Overall wage growth should be rising to 5% under the labor shortage theory. Instead, average hourly earnings for private nonfarm workers has slowed to 3.6% over the past three months from a 4.4% peak registered in early 1998 (measured over 12-month intervals). This moderation shows up in the key sectors.

( Wage growth in services has slowed to 3.6% from over 5.1% early this year.

( The financial and real estate sector, which had recorded booming wage growth of 6.6% in early 1998, has slowed markedly to 2.3% by November.

( Retail trade wage growth dropped from 5.2% in mid 1998 to 3.4% last September. During the brisk holiday selling season this sector has bounced up to 4.1%, still way below its prior peak.

( Manufacturing has strengthened from only 1 3/4% growth in late 1998 to over 4% last summer, and most recently registered a 3.4% gain. However, this is the highest reported productivity sector -- 5.7% over the past year, with unit labor costs deflating at a 0.8% rate.

Now, some analysts argue that the wage data understate the true upward push in compensation. Retailers, for example, are offering non-cash benefits in the form of deep price discounts for clothing and other products for their employees. Also, a number of firms are enticing new hires with spiffed-up job training programs.

Well, there's nothing new about non-cash benefits. Personal tax burdens have been rising, largely from real income tax bracket creep and higher Social Security payroll tax thresholds. So it's no wonder that employees seek non-cash forms of compensation, from clothing discounts right up to deferred compensation bonus plans, including stock options.

A more interesting point than understated wages is the New Economy rise in productivity, which has lowered unit wage costs and increased profits. Nonfarm output-per-hour for the business sector is up over 3.1% during the past year, while non-financial productivity has risen by nearly 4%.

If the government properly counted software, telecommunications and the Internet, productivity rates would be even stronger. This is why S&P 500 operating earnings are rising almost 25% over the past year.

The bottom line point to all this is that the overall economy is sound. Inflation is low, productivity is high, wages are moderate and profits are strong. If there is a shift in labor market conditions, it's a small downward move in the demand curve, not the supply curve.

If there were a labor force shortage, then wages should be rising excessively. But it's not happening. Mr. Greenspan works from the same data files as everyone else. Surely he sees this.

Fact is, neither bond traders nor workers have had a great year. Long-term Treasury rates have jumped from under 5% to over 6%. Real average hourly earnings growth has fallen from nearly 3% in early 1998 to 1% currently. OPEC has had something to do with this. So has Mr. Greenspan.

One final point. The long-run objective of promoting greater labor force supply will best be met by reducing government obstacles to work, not by raising interest rates. To wit: remove immigration limits, eliminate the Social Security earnings test for healthier retirees who wish part- or full-time work (as Gov. Bush has proposed), and reduce the tax-rate on personal and FICA payroll incomes.

Workers work for real wages, after-tax. The best medicine for labor and capital is King Dollar and lower marginal tax-rates.

Remember Art Laffer's supply-side dictum: tax something more, you get less of it. Tax something less, you get more of it. Like other factors, the labor supply responds quickly to tax incentives and regulatory relief. Marx is dead and wrong. Laffer is alive and right. Greenspan can seek redemption.

JWR contributor Lawrence Kudlow is chief economist for Schroder & Co. Inc and CNBC. He is the author of American Abundance: The New Economic & Moral Prosperity. Send your comments about his column by clicking here.


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11/23/99: Y2K Money: Inflationary or Not?
11/16/99: Investor Retaliation
11/05/99: Rosy Lives
10/29/99: Drain Reserves
10/22/99: Supply-Side Is Mainstream
10/14/99: Y2K will likely bring more prosperity
10/07/99: Clinton's tax-cut veto
10/01/99: What's really bugging the stock market?
09/23/99: Growth Trade
09/09/99: Bad Dollar Logic
09/09/99: Buttered bread
08/31/99: Bull Market Alive and Well
08/26/99: Let Prices Rule
08/19/99: Blame OPEC, Not Growth

©1999, Lawrence Kudlow