SYNOPSIS: Krugman links the decline in the NAIRU to a decline in labor unions and worker militancy

Our Valentine's Day getaway didn't quite work out as planned. Like thousands of other Americans, my wife and I were victims of the sickout by American Airlines pilots. I've been stranded by strikes before--in France, Italy, England, you name it. But this was America, where such things are rare.

It was not always thus. When I was growing up in the suburbs of New York City, it seemed there was always some kind of strike in progress--the Long Island Rail road, the teachers, the garbage collectors. A quick look at the Statistical Abstract of the United States backs this up: In 1970 almost 2.5 million workers spent at least some time on strike, and more than 50 million days of work were lost. In 1996, only 273,000 workers were involved in strikes--and fewer than five million workdays were lost. The once-belligerent American worker has become a pussycat.

The decline in worker militance is part of a much broader change: In the modern American economy, workers have become remarkably reluctant to demand large wage increases, and employers even more reluctant to grant them. The resulting wage restraint is key to understanding the amazing ability of the U.S. economy to just keep on growing, long past the point at which most pundits (me included) thought inflation would finally rear its head.

Not too long ago, most economists thought "full employment" really meant something like 6% unemployment, because that was the point at which inflationary wage increases would kick in. That is what happened in the late '70s when inflation exploded--with a lot of help from soaring oil prices, to be sure, but also because of double-digit wage increases, led by big settlements in steel, autos, and other industries with strong unions. It happened again in the late '80s: As unemployment fell below the 6% mark, wage increases started to take off, and the Fed raised interest rates. (It overdid it, created a recession, and made Bill Clinton president.) But now unemployment is at its lowest level in 25 years; complaints about labor shortages are widespread; and yet wages rose less in 1998 than in 1997. True, inflation has been held down by the Asian crisis (which has kept the prices of commodities low) and by good news on the productivity front, but the quiescence of wages is the most important reason we seem able to run a fuller-employment economy than anyone thought possible.

Why don't wages go up the way they used to? A couple of years ago, when tales of downsizing were splashed across the front pages, many people argued that workers were too intimidated by the threat of layoffs to ask for higher pay; but polls suggest that the anxiety has abated in a tight labor market. Ask labor economists why the tradeoff between unemployment and wage increases seems to have vanished, and you get a grab bag of reasons. One is the dramatic weakening of the union movement--although that just pushes the explanation back a step, since the decline of unions is itself something of a mystery. Another answer is demographics: Workers are now older than before, and older workers tend to have lower unemployment than the young. Still a third answer is that our labor market has become more efficient, thanks to temporary agencies, outsourcing, and other arrangements that match workers with jobs more quickly.

Probably the most persuasive story is that wages don't rise even in a tight labor market because companies are too worried about their own competitive position. In the old days General Motors or U.S. Steel would buy labor peace by granting hefty wage settlements, then pass on the cost to consumers. These days competition among firms is more intense (why? good question), and nobody wants to let costs get out of line.

Whatever the reason, wage restraint does wonders for our ability to run a hot economy without inflation. An old analogy likens inflation to what happens when there is exciting action on a football field: Everyone stands up to get a better view, but in fact they see no better and are uncomfortable besides. Here we are with the best game in a generation, and everyone is politely sitting. It's an impressive performance--who thought that brash Americans would be so well behaved?

The big question, of course, is how long it will last. Employment can't grow twice as fast as the working-age population forever, and the latest wage data do show faint hints of an inflationary takeoff. But what a run we've had!

Originally published in Fortune, 2.29.99