Statements to Congress - Statements by Alan Greenspan to the Senate Committee on the Budget and the Senate Committee on Finance

Federal Reserve Bulletin, March, 1997

Reaching some judgment about the reasons for this departure from past patterns is important. As I see it, heightened job insecurity explains a significant part of the restraint on compensation and the consequent muted price inflation.

Surveys of workers have highlighted this extraordinary state of affairs. In 1991, at the bottom of the recession, a survey of workers at large firms indicated that 25 percent feared being laid off. In 1996, despite the sharply lower unemployment rate and the demonstrably tighter labor market, the same survey organization found that 46 percent were fearful of a job layoff.

The continued reluctance of workers to leave their jobs to seek other employment as the labor market has tightened provides further evidence of such concern, as does the tendency toward longer labor union contracts. For many decades, contracts rarely exceeded three years. Today, one can point to five-and six-year contracts-contracts that are commonly characterized by an emphasis on job security and that involve only modest wage increases. The low level of work stoppages of recent years also attests to concern about job security.

Thus, the willingness of workers to trade off smaller increases in wages for greater job security seems to be reasonably well documented for this particular business cycle expansion. The unanswered question is why this insecurity has persisted even as the labor market has, by all objective measures, tightened considerably. One possibility is the ongoing concern of workers about job skill obsolescence. The reality of this obsolescence is evidenced by the marked expansion of on-the-job training programs, especially in technical areas, in many of the nation's corporations. No longer can one expect to obtain all of one's lifetime job skills with a high school or college diploma. Indeed, continuing adult education is perceived to be increasingly necessary to retain a job.

Certainly, there are other possible explanations of the softness in compensation growth in the past few years. The sharp deceleration in health care costs, of course, is cited frequently. Another possibility is the heightened pressure on firms and their workers in industries that compete internationally. Domestic deregulation has had similar effects on the intensity of competitive forces in some industries. In addition, the continued decline in the share of the private work force in labor unions has likely made wages more responsive to market forces-indeed, the converse is also true in that the new competitive realities have in many instances undermined union strength. In any event, although I do not doubt that all these explanations are relevant, I would be surprised if any were dominant.

Another potential explanation is that persistently low price inflation is constraining wage increases. Historical evidence clearly indicates that price inflation is a factor in wage change. But, if the causation is running mainly from product markets, where prices are set, to labor markets, where wages are set, then we would expect to see some squeeze on profit margins. Clearly, this is not the case at present. Rather, owing in part to the subdued behavior of wages, profits and rates of return on capital have risen to high levels. The high rates of return, in turn, seem to be inducing competitive pressures that limit the ability of firms to raise prices relative to their underlying cost structures because they fear that competitors anxious to capture a greater share of the market will not follow suit. Thus, the evidence seems more consistent with the view that wage restraint is damping price increases than the other way around.