The Immigration Safety Valve: Keeping a Lid on Inflation

More than any other factor, the state of the U.S. labor market has colored the Federal Reserve's ever vigilant outlook on inflation -- which is not surprising, since 70 percent of business costs are labor costs. Fed Chair Alan Greenspan has repeatedly pointed to the state of labor markets when justifying interest rate increases: as he declared recently, "There has to be a limit to how far the pool of available labor can be drawn down without pressing wage levels beyond productivity."

Greenspan may have cause for concern. America's booming economy is putting so many people to work that the fight to hire the remaining workers could spark wage-driven inflation. During good times, as firms become increasingly desperate for labor -- especially of the skilled sort -- they generally boost their wages to attract workers from the diminishing labor pool. And today's robust economy is giving Americans more and more money to spend, accelerating growth further. Both trends are classic precursors of inflation.

But the Fed has yet to tighten monetary policy substantially, apparently feeling that the economy is still not too hot, not too cold, but just right. The reason is that the large, steady influx of foreign labor into the United States -- coming from legal immigration, illegal immigration, and the temporary employment of skilled workers -- keeps adding enough new workers to the economy to ease pressure on wages. U.S. labor costs have grown at an annual rate of only 1.5 percent in the second half of the 1990s, compared to about 3.5 percent in the 1980s. Even as job growth has soared in the past year, labor costs and wages have shown few signs of accelerating.

Temporary employment is especially vital in relieving pressure in the tightest areas of the labor market, such as the high-tech sector, where wage inflation is most likely to occur. In 1998, some 24 percent of immigrants who had entered the U.S. labor force between 1995 and 1998 had occupations classified as professional and technical specialties, compared to 16 percent of all workers. Of course, wage inflation can be created by low-wage industries as well -- if there aren't enough workers in a sector. Therefore, less-skilled workers can cause inflation just as much as high-skilled workers can. Although the high-tech sector is the most sensitive area, all immigrant workers help keep inflation from picking up -- and keep the Fed from raising interest rates.