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The theoretical relationship between falling unemployment and rising inflation has come to be known as the Phillips curve, after English Economist Alden Phillips. In 1958 he marshaled almost a century's worth of data from the British economy to show that falling unemployment drives up wages. Conversely, he asserted, rising joblessness forces wages down. The movement of wages heavily influences the level of inflation. But many experts, including Arthur Rolnick, chief economist of the Federal Reserve Bank in Minneapolis, question whether the Phillips curve works that neatly in the real economy. In the 1950s, the skeptics point out, the economy experienced both low inflation and low unemployment, while in the 1970s, prices kept on jumping even as joblessness rose.
So far in 1988, the falling unemployment rate has not led to dramatic increases in wages. For the first three months of the year, workers' average hourly compensation rose by 3.5%, up only slightly from a 3.2% gain during the fourth quarter of last year. Barry Bosworth, an economist at Washington's Brookings Institution, suggests one reason for the modest wage hikes: "Workers have been mainly concerned about job security." Employees know that companies move production overseas when their labor costs become too high. As a result, during recent negotiations workers have moderated their demands for wage increases in exchange for greater security.
Labor's acquiescent posture could easily change. More and more employees are noticing that their companies' top executives have been taking home hefty salary increases and juicy bonuses. But the average American worker has suffered a 6.5% decline in wages, after adjustment for inflation, during the past decade. At some point, says Bosworth, "workers will begin to focus on that loss." That could lead to demands for substantial pay hikes.
While wage gains have remained moderate, other signs point to strong economic activity that could accelerate inflation. U.S. factories were operating at an average of 82.5% of their total capacity in March, up from 80.3% a year earlier. Some industries, including chemicals and paper, are running at more than 90% of capacity. When production is so strained, shortages develop and prices are likely to surge. Another indication that the economy may be running ahead of itself is the level of corporate profits -- up 24% in the first quarter of the year from the same period in 1987. Business investment expanded at an annual rate of 21% during the first three months of 1988.
While few economists consider the evidence of overheating to be conclusive, many are concerned. Says Lyle Gramley, a former Federal Reserve Board member who is now chief economist of the Mortgage Bankers Association of America: "We don't have an explosion of inflation, but it is clear that the inflationary process is under way." And once inflation gets going, it has a momentum all its own. Last week, for example, Continental Can announced a 14% increase in the price of its aluminum cans. That jump alone may set off a round of increases in the cost of beer, soup and soft drinks, since these products are sold in aluminum containers.