The Natural Rate of Unemployment

Man cannot impose his will on nature until he first ascertains what her will is. She sets the rules that make cause and consequences inseparable, and passes the laws by which man must live. In his interaction with nature and the physical universe man is eagerly searching for her ordinances and readily submitting to her will. But in his inter-human relations he is ever desirous of declaring his independence. He defies her will and makes his own rules; he passes laws and regulations by counting votes, and creates governments that are to enforce his wishes. Relying on legislators and enforcement officials, he seeks to modify nature or, if she should not bend, ignore her entirely.

It is unnatural that man should be unemployed. There are countless needs and wants not fulfilled, desires not met. Labor is the great provider and producer of wealth; it moves all other causes. And yet, there also is unemployment because political man wants to modify human nature. He passes minimum wage laws and assigns costly benefits that exceed the productivity of millions of individuals. He makes them “uneconomical” and thereby condemns them to unemployment. Having created an army of unwanted workers, he then seeks to inflate and depreciate his currency in order to generate new demand for labor. But all the currency depreciation cannot for long alleviate the unemployment. It lingers on year after year as if it were sustained by natural law.

A few writers actually postulate a theory of a “natural” rate of unemployment. Their intentions are laudable, seeking to dissuade government from inflating the currency in order to create more jobs. All such efforts are futile, they contend, because inflation does not affect the “natural” rate. But despite their noble opposition to currency depreciation, these writers quietly acquiesce in the policies that are creating the unemployment. They speak of “natural rates” that actually are the rates of human folly that is causing the unemployment. They are elevating folly to “nature” and thereby reinforcing the folly.

In a staff study prepared for the Subcommittee on Monetary and Fiscal Policy of the Joint Economic Committee of the U.S. Congress,^[1] Lowell E. Gallaway and Richard K. Vedder define the “natural” rate of unemployment as “the minimum sustainable rate of unemployment for the economy given a stable rate of price inflation. Put another way, the ‘natural’ rate of unemployment may be thought of as the ‘equilibrium’ rate of unemployment.”^[2] The authors thereby seek to remove the unemployment phenomenon from the political arena and elevate it to an equilibrium. According to Galla-way and Vedder, “the ‘natural’ or ‘equilibrium’ rate of unemployment can be thought of as a basic constraint that the economy faces.”^[3]

“Frictional” Unemployment

The natural rate is said to consist of two components: frictional and structural. The former denotes the unemployment that results from economic changes necessitating reallocation and re- employment of labor. The latter, which is the more important component, is said to reflect underlying factors, such as the industrial demand for certain skills, the demographic composition of the labor force, institutional constraints, and the behavioral responses of the total population. Collectively, all these factors are said to shape the “minimum permanently sustainable unemployment rate.”

When economists resort to metaphors borrowed from the natural sciences their understanding is liable to grievous error. The notion of “friction” is borrowed from physics and denotes a force that resists the motion of one body in contact with another. “Frictional” unemployment means to convey unemployment that results from a force resisting full employment. Yet there is no such natural force that gives rise to unemployment. Man chooses between alternatives. He may choose leisure over labor, unemployment over production. He may be unemployed voluntarily or by institutional force. There are no other types of unemployment.

Changing conditions may necessitate changes in employment; they cause no frictions in human behavior. The world is a scene of changes; today is not yesterday, and not tomorrow. Change may be painful, yet ever needful. Economic changes may necessitate labor adjustments in pay, conditions and location. They may require new learning and training and demand new efforts by the individual.

In a free and unhampered market all the changes in the world do not create unemployment unless the individual chooses to be unemployed. He may choose to wait until an employment opportunity presents itself in a more desirable location, in another line of business or with a favorite employer. He may choose to wait for noneconomic reasons, to be closer to his family, or with people who share his religious, moral or political views. His waiting is a matter of choice, his unemployment is voluntary.

On the unhampered market, wage rates for each type of labor adjust continually so that all those eager to work can find a job. At the market wage all jobseekers can get jobs and all employers can find as many workers as they would like to hire.

When seen in this light, even seasonal unemployment is voluntary. In months of intense demand, wage rates must be high enough to attract a sufficient number of workers from other trades and occupations. They may permit the seasonal workers to save part of their earnings during the busy season and remain unemployed in the off season. They may permit some workers to attend school and seek instruction during the school year, which may coincide with the off season. Of course, every season presents its special demand for labor which may offer opportunities to adjustable, mobile labor throughout the year. If some people nevertheless choose to be idle they do so knowingly and voluntarily.

“Structural” Unemployment

It is appropriate, however, to distinguish between voluntary unemployment and so-called “structural” unemployment, the latter relating to unemployment that is “constructed” or “built” by the social and economic institutions of man. It, too, is voluntary in the sense that man chooses to create these institutions and causes them to act in certain ways. But the institutions may be endowed with coercive powers that deny the individual the freedom to choose. The minimum wage law negates the right to employment at compensation rates lower than the minimum. The unemployment it creates is voluntary for the society that enacts such laws, it is involuntary for the individual whom it condemns to unemployment.

“Structural” unemployment may be the product of political intention and design, or it may be the bitter fruit of economic ignorance. Laws and regulations that create the unemployment may be enacted by legislators who are utterly ignorant in economic matters. Enamored of their position of power, legislators may actually believe that they, backed by courts and police, can order the wage rates of their constituents to rise. Many legislators, however, are known to favor such legislation because of its stifling effects on the productive efforts of their competitors. The representatives of industrial labor in the northeastern United States are fervent advocates of ever higher minimum wages because they are fully aware of the consequences. The wage mandates are meant to hamper less productive competitors especially in the South, which hopefully provides more employment for their constituents. Labor legislation in this sense is an indication of class and regional economic warfare that is waged by transfer politicians.

Union Policies

In a broader sense, “structural” unemployment may also be the product of ideas and policies that guide labor unions. After all, it is the very function of unions to exact higher pay for less work, which raises labor costs and reduces the demand for labor. The unemployment it creates is “voluntary” in the sense that society voluntarily creates the union phenomenon; it is involuntary for the individual who is cast out of productive employment. Unfortunately, most sources of in formation never touch on this structural unemployment.

The U.S. Department of Labor may provide detailed information on males and females, whites and blacks, and many other interesting criteria, but it steadfastly ignores the most important employment factor: union membership. It may report on severe unemployment in Michigan, Ohio, Pennsylvania, and New York, and ignore the fact that the depressed industries usually are unionized industries: automobile, coal, steel, and transportation. In fact, the mass of detailed information seems to be designed to obscure the fact that the strongholds of labor unions also are the centers of unemployment.

Structural unemployment may also be “purchased.” That is, we may speak of “purchased” unemployment when the institutional benefits of unemployment, i.e., the state compensation, supplementary benefits by company and union, health-care benefits, foodstamps and other gratuities, induce some people to prefer unemployment over gainful employment. Surely, many people can be induced to withdraw from the labor market if the price is right. Most people may withdraw when the benefits equal or exceed the compensation for labor exertion. Millions actually withdraw when the subjective value of the free time granted by unemployment together with the transfer benefits exceed the subjective value of the wages earned by labor exertion. When seen in this light, the transfer society is “purchasing” a given unemployment rate. Its willingness to grant benefits is an important factor affecting the unemployment rate.

The Range of Skills

The “underlying forces” do not cause unemployment. Not the industrial demand for certain skills, nor the demographic composition of the labor force, nor the behavioral response of the population can be charged with the gradually rising unemployment rates. It is erroneous to contend that “the wider the range of skills among the labor force, i.e., the greater the disparity among workers’ ability to perform in the work place, the more likely it is that those at the bottom end of the skill distribution will be unable to find employment.” (Gallaway and Vedder, p. 4)

If it were true that a widening range of skills in a given labor market would cause unemployment, it would follow logically that the technically most advanced countries would suffer the highest unemployment rates. The United States, Germany and Japan would be not only the centers of high technology but also of high unemployment. Such a conclusion belies the facts. The unemployment rate in some less developed countries, such as Mexico and many others, exceeds by far that of the technically more advanced countries. Unemployment in every country is a cost phenomenon; it has no relation to the given range of technological knowledge and skills. Workers everywhere acquire most of their skills on the job. They are learning continually as they are advancing slowly from young trainees to senior craftsmen. They are fully employed all their lives as long as they do not price themselves out of their respective markets. This is true for the most skillful worker as well as the most inept.

Learning may be a dangerous weapon and apt to hurt its master if he cannot use it. In many societies the costs of education and training are practically free to the trainee, which gives rise to a massive demand for training and immense misallocation and waste of labor. Free education and training tends to give rise to false hopes and expectations, which, in the end, may bring disappointment and discontent.

The Demographic Mix

Among the various determinants of structural unemployment the changing demographic mix is said to play an important role. Over the years there has been a relative increase in the number of females and teenagers in the labor market, people with relatively little skill. They are reported to have driven up the amount of employment and the rate of unemployment. According to Gallaway and Vedder, “among the 1619 group (both sexes) the civilian labor force participation rate rose from 44.0 percent in 1960 to 58.0 percent in 1979. Among females, aged 20 and over, the increase was from 37.6 percent in 1960 to 50.6 percent in 1979.” (p. 12) If the level of skills actually affects the rate of unemployment, it follows that the influx of young people with few skills must bear some of the responsibility for rising unemployment.

Actually, the level of productive skill merely determines individual productivity and labor income; it has no bearing whatever on employment and unemployment. Surely, unemployment is more concentrated among females and young people who are congregating in white collar and service areas. They are flocking to these areas for a great number of reasons. Union rules and regulations may bar them from industrial employment, which makes white collar and service areas the only entrance gates to the labor market. As millions of females and young people are streaming through those gates, wage rates tend to be relatively low. They may approach the minimum allowable rate, the legal minimum. When they fall below this rate unemployment raises its head. It rises or falls, always reacting directly to the excess of the legal rate over the market rate.

The high rate of unemployment among females and young people also reflects a large component of “purchased” unemployment. After all, the difference between income from work and unemployment benefits may be minimal. When it is smaller than the value of the free time gained by unemployment it is reasonable and economical to seek unemployment. Many young people attach extraordinary value to free time that can be devoted to so many exciting pursuits.

Behavioral Responses and Other Differences

Structural unemployment is said to reflect the basic attitudes of people seeking work. Man’s frame of reference, outlook, disposition, temper, and morale may change over time. His ethos of labor may change, which may affect the usefulness and productivity of his labor, and thus also the market price. Wage rates rise or fall depending on the contribution made by labor to the production process. How do they affect unemployment?

Behavioral differences, even ethnic differences, may explain differences in income and wealth; they may have a bearing on unemployment only in conjunction with government wage mandates and transfer temptations. That is, differences in the ethos of labor, for any reason, do not cause unemployment unless they encounter the given obstacles: false pricing of labor backed by brute force, and benefit temptations giving rise to “purchased” unemployment. In his offer of labor,every individual, regardless of his ethnic background, faces price and cost considerations. He can find employment as long as he does not become ensnarled in one of the “safety nets” spun by government.

It is unnatural that man should be unemployed. To proclaim a “natural” rate of unemployment is most unnatural. []

1.   U.S. Government Printing Office, Washington: Dec. 17, 1982, 11-8030.

2.   Ibid., p. 2.

3.   Ibid.