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.

Without workers from India and Mexico -- as well as from China, the Philippines, El Salvador, Canada, the Dominican Republic, Vietnam, Russia, and Guatemala -- the Fed would long ago have raised interest rates to dampen inflation. Since 1990, immigrants have filled almost 5 million new jobs -- which would just about cover today's level of unemployment. Absent this immigrant labor pool, the U.S. unemployment rate, instead of hovering around its current historic low of four percent, would in fact be much lower.

It is not always necessary for foreigners to move to the United States to join its labor market. U.S. corporations have also managed to expand their labor pool to include overseas workers. For instance, some U.S. companies have established medical insurance claim-processing facilities in Ireland and the Caribbean; others are employing computer programmers in Lahore, Pakistan. Even this offshore labor force helps protect the U.S. economy from inflation.

So what would happen if the unemployment rate dropped even further? Wages would rise rapidly, too much money would be chasing too few workers and goods, and inflation would pick up. The Fed would then squeeze the brakes on monetary policy and sharply raise interest rates. The resulting downturn in growth would make the U.S. economy that much smaller -- and weaker. All this could happen if the United States shuts its doors to immigrants.

WHO WANTS TO BE A MILLIONAIRE?

All nations can experience labor shortages in skilled professions, such as computer programming. But the United States has an easier time recovering from these than most. One explanation is the worldwide use of English among skilled workers. For some observers, such as Kaoru Yosana, Japan's minister of international trade and industry, English alone explains America's appeal to workers. "English has become a common language, so it's natural for the best and brightest to go to America to study," Yosana argues.

Beyond language, however, many young, talented professionals around the world are finding an alternative to toiling for a large local company: the prospect of making it big by working for a start-up high-tech company in the United States. It is no wonder that more people are choosing the riskier U.S.-bound path. Stock options are a global magnet for the high-tech elite, regardless of their places of birth. For example, almost half of all recent graduates of the prestigious Indian Institute of Technology (IIT) have come to the United States after graduation; by some estimates, 20 percent of IIT alumni now work in America. Fatigued by overregulation, high taxes, stifling career paths, and entrepreneurial impediments, a growing number of young Europeans, Asians, and other foreigners are ready to move to richer U.S. shores.

But from the perspective of other nations, America's pull on the world labor market spells disaster. The French media, for example, are crying about a "hold-up," by which the United States is robbing many countries of their best workers. And their native countries have cause for concern -- they fund the educational and professional training that lets young workers acquire the skills the high-tech industry seeks. Foreign workers hoping to find their success in the United States are typically among the more ambitious and dynamic members of their societies. Just as these ambitious workers become productive, taxpaying citizens, they begin dreaming of coming to America.

Politicians abroad are beginning to feel the pressures of the American "global brain drain." In a world where knowledge and entrepreneurship are the keys to prosperity, a country's main economic resource -- its brightest and most creative people -- can simply walk out the door.

U.S. immigration policy is quite strict -- and many Americans would restrict it further. But those who want to close U.S. doors even tighter need to consider this basic fact: immigration has been a key element in making the U.S. economy the envy of the world in the 1990s. It is in America's interest to keep it that way.