INTRODUCTION:
The Philips Curve gives a relationship between the rate of wage inflation and rate of unemployment. Published way back in 1958 by A.W.H Philips, it is used extensively by economists and policy makers to determine the state of economies as well as make policy decisions. In simple terms the Philips Curve says that the rate of inflation is inversely proportional to the unemployment rate. Its logic is straightforward, when workers are hard to find, employers tend to raise wages to find more workers leading to higher wage inflation. When workers are plenty or when employers are reducing their headcount, there is a tendency to reduce wages or at least put a leash on wage inflation. Several economists have also drawn a relationship between general price inflation and unemployment and found that it is similar to the Philips Curve. Therefore when people talk about Philips Curve they usually refer to the inverse relation between general inflation and unemployment.
This straightforward logic between wages and unemployment has been challenged by many economists. Edmond Phelps and Milton Friedman have independently questioned its logic . The advent of the internet age has created a global pool of workers and the simple logic of raising wages when workers are scarce no longer holds. Employers have different options like outsourcing, bringing in guest workers and automation to take care of their labor needs.
UNDOCUMENTED WORKERS:
There have been few commentaries on the effects of Undocumented workers on inflation. However no one can deny that the estimated 11-20 million undocumented workers form an integral part of the US workforce and must be taken into account when calculating the unemployment rate. US Department of Labor has clearly mentioned in its reports that questions regarding ‘legal status’ are avoided when taking employment surveys. It goes on to say that many undocumented workers are counted as part of the labor force. The problem with this approach is that undocumented workers are not likely to claim unemployment benefits and are very unlikely to claim that they are looking for a job(due to fear of deportation). It is therefore not possible to gauge whether they are looking for a job. These workers won’t be covered in any of the other surveys by DOL. Hence the presence of a large number of undocumented workers will necessarily lead to a lower unemployment rate.
PRESENCE OF TEMPORARY GUEST WORKERS:
From DOL survey methods it is not clear if they are accounting for guest workers coming to the US on various work visas like L, H etc. These workers can be called a migratory workforce as they cannot legally remain in the US once they stop working unless they change their visa status. They constitute a significant portion of the workforce. For the year 2006 approximately 1.709 million non-immigrant work visas were handed out. Their effect on unemployment rate is very similar to that of undocumented workers, i.e. they tend to lower unemployment rates as their jobs are counted when they are working but their numbers are not counted when they are unemployed.
EFFECT ON UNEMPLOYMENT RATE (1995-2005):
The number of undocumented as well as guest workers is clearly dependent on overall economic growth. To measure their effects on unemployment rate we can assume a threshold GDP growth of 3.0 %( Considered as the threshold growth rate to create sufficient jobs to cover increase in population. Growth rates above this number will likely result in a decrease in unemployment rate and an economic incentive to undocumented workers, growth rates below this number will be an economic disincentive to undocumented workers).
US GDP growth exceeded this threshold during 1996 – 2000 and 2004-2005.Therefore during 1996-2000, there was a clear incentive for undocumented workers to come to the US. We can infer that their numbers increased substantially during 1996-2000.
EFFECT ON INFLATION RATE AND WHY THE PHILIPS CURVE CAN STILL BE USED (1995-2005)
During 1996-1998, US inflation rate declined from 2.93 to 1.55 . During this period, unemployment also decreased from 5.41% to 4.22% . This can be attributed to a large influx of undocumented workers. Presence of a large number of workers ready to work at very low wages will drive down inflation. However the wages of DOCUMENTED workers will still increase as they are in a premium during periods of strong economic growth. Therefore the basic premise of the Philips curve still holds true and there is an inverse relation between wage inflation (as measured for documented workers) and unemployment. The overall inflation rate does not follow wage inflation due to presence of undocumented workers.
The year 2000 saw a decent 3.7% US GDP growth. The previous years of above threshold growth had reduced the number of both undocumented as well as legal workers in the US. The full effect of low unemployment was visible and the inflation rate spiked to 3.38
During 2000-2002, the inverse relation between inflation and unemployment seems to hold good and we can also see that growth was below 3.0% indicating an economic disincentive for undocumented workers.
The period 2003-2005, also has an inverse relation between inflation and unemployment, telling us that the Philips curve can still be used. The point to note here is a GDP growth during 2004-2005 was above the threshold (3%), indicating an economic incentive for undocumented workers. However border security and workplace enforcement were greatly increased after 2001, taking many undocumented workers out of the workforce.
CONCLUSION:
We can see that the Phlips Curve is a handy tool to economic planning despite the presence of several technological improvements as well as different options available to employers. One reason may be that outsourcing and automation can only remove a tiny percentage of jobs and won’t effect the overall inverse relation between inflation and unemployment.
