Business & Technology 8/30/99


Are raises bad for America?
The Fed's hawks think so. But pay hikes have yet to spark inflation

BY WILLIAM J. HOLSTEIN


Highflying Dell Computer is on a hiring tear, with plans to add as many as 5,000 people to its payroll over the next year. Problem is, the job market in its hometown, Austin, Texas, as in many other parts of the country, is tighter than a pair of bicycle shorts. In particular, demand for such specialists as systems engineers and programmers is white hot, and pay levels are inching up. But Dell wouldn't dream of charging more for its personal computers to offset rising labor costs. "We're not in the business of passing through price increases," says Vice Chairman Kevin Rollins. "We're passing through price decreases." Indeed, the company recently introduced a PC that sells for just $829, its cheapest ever.


Whether companies like Dell can keep hiring without spawning inflation is the economic puzzler that the Federal Reserve Board and Chairman Alan Greenspan are pondering. The Fed raised interest rates by a quarter percentage point earlier this summer and is widely expected to hike them again when it meets this week. The issue now is whether the central bank will continue jacking up rates–and whether it's at all necessary to do so.


Worried hawks. The Fed's leading hawk is Laurence Meyer. He and other inflation-phobes are worried that American workers' recent pay gains will translate into inflation. The most recent worrisome note: Hourly wages rose faster in July than at any time since January.


But changes at the ground level in the American economy suggest that the linkage between increased wages and inflation isn't as ironclad as it once was. Like Dell, companies are going to great lengths to pay certain categories of workers more without passing those costs on to consumers. They are also tapping new pools of labor, both urban and rural. Dell, for example, has opened a factory in job-hungry Tennessee, where it has been flooded with 7,000 résumés for 700 positions. Similarly, telecom giant Sprint has opened a call center in downtown Kansas City, hiring mostly former welfare recipients. It is now rolling that program out in other cities.


To find the right workers at the right price, companies also are relying on new tools such as Internet searches and online job listings at Monster.com and Jobtrak.com. Classified ads in newspapers are increasingly available online, and many companies list job openings on their Web sites so that a restless worker in, say, San Diego can quickly scout out job openings in New Hampshire and apply online.


In short, labor-force management is suddenly one of the most important issues facing corporate America. The reason is simple. Aside from a handful of sectors such as construction materials and medical services, the vast majority of companies don't have pricing power, meaning they can't charge more for the things they sell. "Companies are under very severe competitive pressures, which make it impossible or very difficult to pass on labor cost increases even if they occur," says Richard Rippe, chief economist at Prudential Securities in New York.


Moreover, the "churn" rate in the work force is exceptionally high. Despite a booming economy, outplacement consultant Challenger, Gray & Christmas says American companies will lay off more than 700,000 workers this year, the most this decade. Yet overall unemployment remains at 4.3 percent. The implication is that employers are shedding older, more expensive workers and replacing them with new employees or relying on various forms of contingent labor. "Downsizing is a valve that releases wage inflation steam," says John Challenger, chief executive of the Chicago-based firm.


Changes in the nature of American labor markets lead the more dovish economists to argue that, yes, maybe one day tight labor conditions will trigger inflation, but it isn't happening yet. They point out that there isn't much evidence of statistically meaningful inflation in either the latest consumer or producer price indexes. The 0.3 percent July increase in consumer prices announced last week, for example, was right in line with expectations and didn't reveal wage-induced price pressures.


Besides, raising interest rates too much, the inflation doves argue, will choke off growth that is finally reaching Americans who haven't really benefited from the eight-year economic expansion. For example, Larry Kudlow, chief economist at Schroders in New York, points out that there are still nearly 6 million American adults who are unemployed. Says Kudlow: "You've got a lot of job resources out there."


Blue-chip bounty. The sector where workers are truly scarce, however, is information technology, with some 400,000 jobs reckoned to be open. Texas Instruments, the semiconductor company, has 800 jobs it hasn't been able to fill in Dallas. To find warm bodies, the company pays $1,500 to any employee who recruits a new worker and gives him or her a chance to win a new, fully loaded Ford Explorer that's parked in the lobby at headquarters. Even so, a shortage of experienced chip designers has pushed starting salaries up from $55,000 to about $65,000 over the past five years.


But Roger Coker, TI's director of staffing for the United States, says the company is using every trick in the book to fight labor cost creep. It has started offering stock options to more employees, making them available not just to vice presidents but to all managers. That eases some of the pressure for increased salaries. The company is also fighting in Washington to allow more foreign engineers and designers to take jobs in the United States on temporary H-1B visas. In addition, it is using the Internet to hire 28 percent of its experienced engineers and 17 percent of its new college graduates, which greatly cuts the cost of recruitment.


Just as Sprint and others are tapping new urban workers, TI is scouring smaller rural communities for talent. When Coker got wind that a factory was closing in Wichita Falls, Texas, his recruiters went there and found 13 workers, whom the company relocated to Dallas. Meanwhile, TI is pushing for major new productivity gains by increasing the size of silicon wafers, for example, which will reduce the cost of each chip cut from the wafer. The net effect, says Coker, is that "I don't see labor costs translating into the pricing structure of our products."


The reason high-tech employers have trouble finding people–even at a time when folks remain unemployed or underemployed–is the mismatch of jobs and skills. But employers are attacking the roots of that problem, forming alliances with local educational institutions to create more workers with the right skills. A recent example is a $70 million technology and engineering institute that major employers in Omaha unveiled on August 21. "It used to be that we would go to recruiting fairs and take what we could get," says Bill Fairfield, chief executive of Inacom, a $4 billion computer services company that helped spawn the institute. "But today we're trying to shape the students."


Train, not raid. With 1,700 employees in Omaha, where unemployment is below 3 percent, Inacom is frustrated by how long it takes to find skilled workers to manage help desks, for example. Compensation for such employees has increased by about 5 percent recently. Fairfield says Inacom could raid other companies for talent, but that ratchets up every company's compensation tab. Hence the willingness to pool resources to create a bigger stream of employable young people. "There's no question it's a structural change" in the relationship between employers and schools, adds Fairfield.


Are all these microeconomic tools enough to hold off inflation? Challenger thinks they may be. He argues that the economy is "self-correcting" because employers will do whatever it takes to avoid passing increased labor costs through to the marketplace. But Diane Swonk, chief economist of Bank One, also in Chicago, thinks it's inevitable that tight labor conditions will spark inflation.


Swonk notes that smaller companies, particularly in the service sector, don't command all the tools that bigger companies have to hold wage costs down. "We have seen a turning point," she says. "It will be so gradual that it's hard to notice, but that doesn't mean it hasn't occurred." Other like-minded economists are calling for the Federal Reserve to increase interest rates by a full percentage point by the middle of next year.


For now, at least, the absence of clear inflationary signals in the consumer and producer price indexes strengthens the hand of experts who argue that something has changed in the economy, loosening the automatic linkage between full employment and inflation. They don't argue that inflation will never occur, just that current gains in employment and income aren't yet a threat. If they're right, the U.S. economy could keep on expanding, making it to the nine-year mark in February. But as everybody knows, Greenspan could cork the bottle at any moment and ruin the party.