The Natural rate is mainly composed of frictional and structural unemployment, therefore, factors that affect these types of unemployment will alter the natural rate.
It is argued the level of unemployed benefits can affect frictional unemployment. If the ratio of benefits to paid employment is high then there is little incentive to take a job. For example, since the early 1980s unemployment benefits have been index linked ( this means increased in line with inflation). Wages have tended to rise faster than inflation, therefore, the difference between benefits and paid employment has grown increasing the incentive to get a job, and therefore, reducing the natural rate of unemployment in the UK.
Similarly the wages of the lowest paid will greatly affect the incentives to take a job. In the UK the govt has introduced a national minimum wage and increased it from £3.60 to £5.80.(2009) This has made work relatively more attractive compared to staying on benefits. Also, the New Deal has been introduced to try and encourage the unemployed back into work. The New Deal involves giving workers retraining schemes and interviews to help them find work. Also, if workers are offered a job after 6 months they have to accept it or risk losing benefits, and hence they will be not counted as unemployed. This has helped reduce the natural rate.
A key factor affecting structural unemployment is the geographical and occupational mobility of labour. If workers were more mobile this would help reduce unemployment caused by a mismatch of skills and geographical location. For example, in the past decade, the north south divide has been reduced in the UK, this is due to regeneration in areas, which used to suffer high unemployment. New industries have taken the place of former heavy industry which have closed down, this has enabled a reduction in geographical unemployment.
If workers became more skilled through education and retraining this would help reduce occupational immobility’s. To some extent the New Deal has helped retrain workers and give them the necessary skills to be effective in the labour market thus reducing structural unemployment.
The flexibility of the labour market is also a key feature for determining the natural rate. For example, if restrictive practices of trades unions were reduced or minimum wages abolished, then labour markets will becomes more flexible. Thus firms are likely to be more able and willing to hire workers. Arguably, the UK labour market has become more flexible in recent years – to some extent explaining the fall in the natural rate. However, the EU has seen rises in the natural rate; this is often blamed on inflexible working practices such as a maximum working week, restrictions on firing workers and minimum wages.
Another potential cause of the natural rate is the Hysteresis hypothesis. This states that if unemployment increases (e.g. during a recession) then it is likely to remain high for a considerable period. This is because workers become de-motivated and deskilled whilst remaining unemployed and therefore find it difficult to get a job in the future. For example, after the recession of 1981, unemployment in the UK stayed close to 3 million for a long period despite a long period of growth. However, this didn’t happen after the 1991 recession.