Whether you realize it or not, history was made within the past two weeks. Namely, the stock market motored higher for its 3,453rd day in a bull market -- the longest bull market in modern history. To boot, we're also in the second-longest economic expansion (109 months and counting) since record-keeping began in 1853, and the U.S. unemployment rate touched an 18-year low in May at 3.8%. Had it dropped just one-tenth of one percent lower to 3.7%, it would have been at a 49-year low.
By all accounts, the U.S. economy is firing on all cylinders. Yet, by looking at the unemployment rate of 3.9% as of July, and realizing that millions of Americans who seemingly want work don't have a job, you might think that things aren't as good as they could be.
Here's why the unemployment rate never drops too far below 4%
You may even be wondering why, when looking back through 70 years of unemployment data from the Bureau of Labor Statistics, the unemployment rate has struggled to stay below 4% for an extensive period of time. Currently riding a streak of four consecutive months below 4%, the last time such a feat was accomplished was nearly 18 years ago, between September 2000 and December 2000. All told, since February 1970, there have been just nine months in aggregate where the unemployment rate has been below 4%.
So, why does the unemployment rate struggle to push significantly below 4%? The answer is what's known as the "natural rate of unemployment." Just as the name implies, the natural rate of unemployment is the full employment level a healthy economy can expect to achieve as the result of a handful of factors that influence the job market and lead to normal instances of unemployment. According to the St. Louis Fed, the natural rate of unemployment in the U.S. economy was 4.62% during the second quarter of 2018.
These factors are responsible for a natural rate of unemployment in a healthy economy
Let's take a closer look at the three factors that can influence the natural rate of unemployment, as well as a fourth factor that I'm going to toss in that's also pretty important.
1. Frictional unemployment
Frictional unemployment is a type of short-term unemployment whereby a worker leaves one job voluntarily in order to seek out a better job. It can include students looking for work, mothers returning to the workforce, or even workers who've been laid off who have found new work via relocation. Generally speaking, frictional unemployment can be a good thing since it allows workers to find jobs that best suit their skill set and work experience.
2. Structural unemployment
On the other hand, structural unemployment isn't a good thing. This involves a mismatch between unemployed workers' skills and the needs of a business. If, for example, a business moves toward automation, a worker who doesn't have the skills to operate machines would find that his or her skill set no longer matches what businesses in their industry are looking for. Workers displaced by structural employment can remain unemployed for a long period of time, or until they're retrained or gain the skills businesses are looking for.
You might be under the impression that structural unemployment only impacts high-skilled jobs, but you'd be mistaken. As an example, McDonald's (NYSE:MCD) announced in June that it plans to add self-order kiosks and mobile order capabilities to approximately 1,000 stores each quarter. These ordering kiosks remove the need for having a cashier take a customer's order, potentially allowing McDonald's to operate with a smaller staff at its restaurants. Unless McDonald's cashiers can demonstrate other needed skills, such as in the kitchen or in the management department, they could find themselves slowly pushed out of a job by these kiosks.
3. Surplus unemployment
The third factor is surplus unemployment, which is where government intervention in minimum wage laws or wage/price controls impacts the employment rate.
In Seattle, for example, the city council voted in 2014 to progressively raise the minimum wage to $15 an hour by 2021. However, a study conducted by the University of Washington found that, despite being paid a higher hourly wage in 2016, workers were bringing home less income per week. These workers were either working fewer hours or, in some cases, losing their jobs. Businesses only have so much room for expenditures, and higher mandated wages can lead to job loss and/or fewer hours worked.
4. Cyclical unemployment
A final factor that can impact the unemployment rate, but which is not one of the three influencing components of the natural rate of employment, is cyclical unemployment. Here, we're typically talking about workers who are displaced from their job because of seasonality. Examples might include ski season workers being laid off as spring weather approaches, or seasonal hires in retail department stores being let go once January rolls around. It's an oft-overlooked form of unemployment that nonetheless can play a big role in influencing the Bureau of Labor Statistics' monthly employment readout.
Long story short, yes, the U.S. economy is firing on all cylinders, and no, the jobs market is unlikely to get much healthier than it is right now.