phk
phknrocket1k
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« on: February 06, 2010, 03:55:14 PM » |
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« edited: February 06, 2010, 04:00:31 PM by phknrocket1k »
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Okun's law refers to the relationship between increases in unemployment and decreases in a country's gross domestic product (GDP). It states that for every one percent increase in unemployment above a "natural" level, that GDP will decrease by anywhere from two to four percent from its potential.
Although it can be expressed mathematically, and holds up under real-world scrutiny, Okun's law is an imperfect theory, because of unpredictability. For example, the exact amount of unemployment that constitutes natural unemployment is not known, nor can it be.
Another imperfection in Okun's law is that the effect of a given increase in unemployment could be magnified or diminished based on variables like productivity, and general sentiment regarding the economy. These variables are, at best, hard to measure. The definition of unemployment -- not having a job but still seeking one -- also colors the data slightly, because unemployment therefore does not take into account those that stop looking for new work after a certain amount of time.
Despite these imperfections, Okun's law does describe a measurable economic trend in a way that helps economists and students of economics mentally crystallize a certain sequence of causes and effects. The observed relationship between more unemployment and less GDP becomes intuitive, since people who are out of work not only stop producing, but also usually cut back significantly on spending. Also, lackluster economic data such as high unemployment and low consumer spending may discourage investment by businesses.
These two realities, when put together, make it easier to see that unemployment has a multiplier effect that is not limited to a one-for-one type of tradeoff. This is what Okun's law accomplishes, namely the description of this type of relationship as something to be expected. It also implies that unemployment is not the only thing that can affect GDP levels. If both productivity and the number of people in the labor force increase, for example, then GDP will increase even though unemployment statistics may have remained constant. Okun's law is approximate because factors other than employment (such as productivity) affect output.
In Okun's original statement of his law, a 3% increase in output corresponds to a 1% decline in the rate of unemployment; a .5% increase in labor force participation; a .5% increase in hours worked per employee; and a 1 % increase in output per hours worked (labor productivity).
The relationship varies depending on the country and time period under consideration.
The relationship has been tested by regressing GDP or GNP growth on change in the unemployment rate. Martin Prachowny estimated about a 3% decrease in output for every 1% increase in the unemployment rate (Prachowny 1993). The magnitude of the decrease seems to be declining over time in the United States. According to Andrew Abel and Ben Bernanke, estimates based on data from more recent years give about a 2% decrease in output for every 1% increase in unemployment (Abel and Bernanke, 2005).
There are several reasons why GDP may increase or decrease more rapidly than unemployment decreases or increases. As unemployment increases,
* a reduction in the multiplier effect created by the circulation of money from employees
* unemployed persons may drop out of the labor force (stop seeking work), after which they are no longer counted in unemployment statistics
* employed workers may work shorter hours
* labor productivity may decrease, perhaps because employers retain more workers than they need
One implication of Okun's law is that an increase in labor productivity or an increase in the size of the labor force can mean that real net output grows without net unemployment rates falling (the phenomenon of "jobless growth")
Okun's law. Quarterly GNP growth (NOT ANNUALIZED) and change in the unemployment rate. US data from US agencies from a file located here. Data from 2nd quarter 1947 through 4th quarter 2002. Made using SPSS.
Regression results: -1.827 Beta on unemployment change (Std error .123), .856 constant (.049), adj R2 at .504. All vars and f-test .000 signifance. %Change GNP = .856 - 1.827(Change Unemployment Rate)
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