Is the Natural Rate of Unemployment Turning Higher?

In California, the minimum wage has risen to $16.00, vs. $7.25 in Texas.  Even adjusting for differences in the cost of living, the rate in California is much higher.  Of course most workers earn more than the minimum wage, but I suspect that union wages are also higher in California.  For instance, consider this recent article in the Orange County Register:

Workers at 34 Southern California hotels hailed new labor contracts Monday that will boost wages by $10 an hour over four years, ending months of protests and rallies for thousands of employees. . . .

Most room attendants will earn $35 an hour, or $73,000 a year, by July 1, 2027, Unite Here said, while top cooks will make $41 an hour, or $85,000 a year. When benefits are added in, a hotel will pay $100,000 annually to employ a single room attendant.

And yet the US has a fairly unified labor market.  It may be hard to get into the US, but it’s not that hard for a hotel worker to move from Texas to California.  How should we think about this wage disparity?  

My baseline assumption is that workers are not better off in California, as there is currently a strong outmigration from California to Texas.  Much of that is explained by housing, but not all.  To see why, consider a model I recall learning in grad school.  Imagine a poor country with a large rural population and a big city with a few higher paying jobs.  Why doesn’t everyone migrate from the countryside to the city?  Perhaps because most workers would suffer from long periods of unemployment while they searched for one of the few good jobs.  Unemployment becomes a sort of “queuing cost” that subtracts from the expected benefit from high wage employment, and preserves equilibrium between the urban and rural population.  If too many people move to the city, queuing costs increase and the expected benefit from migration declines.

If I’m correct, then California’s recent push for much higher wages should have led to more queuing, i.e., a higher natural rate of unemployment.  And there is a little bit of evidence that this has recently occurred in California:

I don’t want to make too much of this graph.  But it does seem like California has diverged a bit more from the national rate in the post-Covid period (albeit not much in mid-2022, when there were labor shortages almost everywhere.)

At the national level, the natural rate of unemployment seems to have fallen from roughly 6% in much of the 1970s and 1980s, to something closer to 3.5% in the late 2010s.  Post-Covid it’s hard to know for sure, because the natural rate is best measured during periods without either recession of overheating, such as 2019.

California is a big enough state that even an extra 1.4% worth of unemployment adds about 17 basis points to the national rate.  Thus, minimum wage and union policies in California might have slightly boosted the US’s natural rate of unemployment, reversing a nearly 40-year downtrend.  If a few other states have similar changes in labor market policies, it wouldn’t surprise me if the natural unemployment rate had ticked up from 3.5% to somewhere around 3.8% to 4.0%

Assuming there is no recession in 2024, more data will give us a better sense of whether the natural rate of unemployment has indeed turned upward.  In the meantime, I’d strongly encourage the Fed not to focus on the unemployment rate and instead target NGDP growth at 4%/year.  In the 1970s, Fed officials failed to notice a rise in the natural rate of unemployment, and this led to a very costly (inflationary) mistake in monetary policy.  Let’s not repeat that mistake.

Equilibrium is a very powerful concept.  It is often helpful to keep this concept in mind when thinking about questions such as, “What is required for people to be migrating from high wage California to low wage Texas?”   In the past, I would have said “housing prices”.  But now I suspect the answer is “housing prices and employment prospects”.  (It can’t just be employment prospects, as otherwise California housing would be cheap, like Detroit.)

PS.  That $73,000 figure caught my eye.  Because it’s for 2027, you have to lower it to about $66,000 in today’s dollars today for comparison.  Even so, my first year teaching at Bentley (in 1982) I made $22,500, which is like $60,600 today (using the PCE price index as a deflator.)  BTW, I’m not complaining—always happy to see trends like this:

And no, the difference between the inflation rates experienced by low and high-income workers doesn’t even come close to being large enough to offset this gap.

PPS.  In my view, the federal minimum wage has been effectively repealed.  There used to be a debate about what would happen if the US copied Sweden and Denmark by not having a minimum wage law.  The debate should be over.  In Texas, fast food workers earn an average of $17/hour.  Unless you believe that wage is caused by the federal $7.25/hour minimum, that represents the free market wage—the wage without any federal minimum wage law.  Even if minimum wage laws could somehow be justified (they cannot), there would be no justification for a federal minimum.  If it were not set too high for the poorest state, it would be irrelevant in most states.  States are free to set their own minimum wage, reflecting local labor market conditions.