Natural Unemployment To Increase To 7%?

Economics teaches that there's a natural unemployment rate in any economy. That rate is not zero. It's a supply side economic theory that purports that -- even when everything seems great -- it takes time for unemployed individuals to find new jobs. The more efficient the labor market, the lower the natural rate of unemployment. Traditionally, economists have believed that in the U.S. that rate is around 5%. That's why you rarely see unemployment trend much below that percentage. A few notable economic minds have stated that they believe this recession will permanently raise that percentage to around 7%.

Bloomberg reports that Nobel Prize winner Edmund Phelps and Pacific Investment Management Co. Chief Executive Officer Mohamed El-Erian are among those making this claim. Why? Bloomberg refers to an explanation from Harvard economist Lawrence Katz:

Katz identifies labor mobility as a key factor in reducing the natural rate of unemployment. Mobility fell last year to its lowest level since records began in 1948, according to the Census Bureau. The so-called national mover rate declined to 11.9 percent of the population in 2008 from 13.2 percent in 2007 as 35.2 million Americans one year or older changed residence.

JP Morgan chief economist Bruce Kasman also agrees, but for another reason:

Kasman ties an increase in the full-employment rate to the permanent destruction of hundreds of thousands of jobs in industries from housing to finance.

I'm not convinced. It seems that these economists are talking about a permanent shift in the natural rate of unemployment due to seemingly temporary effects. Labor mobility is definitely historically low right now. I've written about this myself. Since the current recession has its roots in housing, it will make moving more difficult. As a result, people can't as easily flee depressed local economies for better employment opportunities elsewhere.

Yet, the housing market will improve and return to normal eventually. It might take several years, and may never again resemble what it did in 2003-2006. But it will eventually look like it used to in the 80s and 90s. Back then, the natural unemployment rate appeared to be around 5%, so why wouldn't it return there when labor mobility improves with the housing market getting better?

Then there's Kasman's claim that so many of the jobs lost are permanent. Weren't an awful lot of jobs lost during the tech bubble's demise seemingly permanent? I don't think many of those dot-com employees quickly found new jobs at similar start-up firms. Certainly, they found jobs somewhere, but those "permanent" job losses don't seem to be any more permanent than those lost in housing or finance.

So I don't believe that the natural unemployment rate will be permanently affected by this recession. But I do agree with what El-Erian says here:

Even with the economy growing, "it will take at least a couple of years" for joblessness to fall to 7 percent from 9.7 percent now.

I think it will take quite a while to get employment down after this recession -- you aren't likely to see a steep fall back down to 5%. Because labor mobility has been affected and so many jobs are lost that won't return, it will take some time. But I just don't buy the argument for that level sticking at 7% indefinitely. I think, in time, it will return to 5%. But it won't happen quickly.