German politicians seem to think so. They are back to their old game of gridlock on much-needed tax reform. Now that the euro has strengthened a bit, and people have stopped blaming the current tax laws for the currency’s weakness, it seems that some officials are ready to play politics again. But that game may be a dangerous one. What if the very conditions that some economists say are beginning to rein in U.S. growth–low unemployment and rising wages–actually propel U.S. businesses toward even more impressive gains in productivity?
Consider the evidence. Yes, U.S. labor costs are clearly showing signs of accelerating, which usually is considered bad news. Wage inflation is typically passed on to consumers in the form of higher prices for goods and services–and thus results in higher inflation. In previous cycles, that meant the Fed had to keep raising interest rates to fight inflation, choking off growth in the process. But today’s U.S. economy is very different from that of 20 or even 10 years ago. Companies that might be inclined to pay more for labor and then pass on the additional costs to consumers can’t necessarily do so.
Why? Because U.S. unemployment is now so low that many companies can’t attract additional workers at any reasonable price. This time around, America’s CEOs cannot expand by simply hiring more workers–so instead, they do everything possible to raise the productivity of existing employees. The employment-cost index jumped 1.4 percent in the first quarter of 2000, its fastest growth since 1989. Yet unit labor costs rose a very moderate 0.4 percent–marginally below the 0.5 percent average over the past three years. The reason is that productivity grew 1.0 percent in the quarter, so the rise in compensation costs did not translate into higher costs for businesses–and therefore should not translate into higher prices for consumers.
Believing that this will continue may sound like wishful thinking. But history indicates that businesses can rise to such challenges. In the late 1980s, Japanese exporters were faced with an apparently insurmountable problem they called endaka. Endaka was simply the fact that the yen kept rising and rising–posing a seemingly deadly threat to the likes of Toyota and Sony, which had grown rich by selling abroad. Every 5 percent rise in the yen essentially meant a 5 percent rise in the U.S. retail price for Japanese products. Outsiders confidently predicted that Japanese exports would become unprofitable, and Toyota would stop shipping cars to the United States. It never happened.
Instead, Japanese companies found savings they had never imagined possible. As the yen rose, Japanese exporters wrung out more and more costs–and they hung on, keeping their retail prices competitive, even as the yen doubled its external value between 1985 and 1990. German companies faced a similar problem, and handled it the same way. At the time many in the United States argued that the country’s businesses could stop worrying about the German and Japanese competition, and let the cheap dollar do their job for them. Fortunately, such views never really got a hearing in corporate boardrooms. Had U.S. business followed that advice, the U.S. economy would likely never have seen the productivity leap of recent years.
U.S. companies must respond to a tight labor market with the agility the Japanese companies displayed in the late 1980s. But there is one big difference: the Japanese response to endaka affected only the export sector. Domestic services, construction, distribution and transportation had no incentive to improve, and the Japanese economy ultimately performed poorly, even while exports boomed. In the present U.S. case, the incentive goes across the board: tight labor markets are producing productivity gains among exporters and domestic producers alike. As U.S. companies react by becoming yet more efficient, the benefits will be felt throughout the economy.
There are those in Europe and Japan who are waiting for “our turn.” They view the signs of slowdown in the United States with self-centeredness. But Europe and Japan won’t be rescued from hard decisions by events elsewhere. U.S. businesses, like Japanese and German business before them, can rise to the new challenge they face. There is simply no substitute for the hard work of restructuring, both in the private and public sector.
