Okun's Law - Explained
What is Okun's Law?
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Table of ContentsWhat is Okun's Law?How is Okun's Law Used?Drawbacks of Okuns LawAcademic Research on Okun's Law
What is Okun's Law?
Okuns law establishes the relationship between the unemployment rate and the Gross National Product of the U.S. economy. So, if the unemployment in the U.S. reduces by 1%, it would result in a threefold increase in its GNP. This law is applicable for the U.S. economy only, and is valid when the unemployment rate lies between 3% and 7.5%.
How is Okun's Law Used?
Besides gross national product, Okuns law also helps in establishing a relationship between the unemployment rate and gross domestic product of the economy. An increase of 1% in unemployment rate would result in the decline of GDP by 2%. Arthur Okun, who was a Yale professor and economist, conducted in-depth research on the relationship between production and unemployment. And after the topic gained recognition in the 1960s, the findings related to this study were named Okuns law. It says that the unemployment of an economy will have a positive impact on the nations productivity. This law helps in ascertaining the gross national product and gross domestic product. The Okun coefficient is the percentage rise in the gross national product when unemployment declines by 1%. Every country has a different relationship between unemployment rates and gross national product or gross domestic product. As per the Okun coefficient, the 1% fall in the unemployment rate in the U.S. will increase GDP by 2% and GNP by 3%. And in case, unemployment increases by 1%, the GDP will fall by 2% and GNP by 3%. Okun coefficients tend to be more in countries such as Germany and France, having lesser flexibility in the labor markets as compared to the U.S. So, for these nations, if GNP changes at the same rate, it will have a lesser impact on its employment rate than in the U.S.
Drawbacks of Okuns Law
Though economists favor Okuns law, it is still not considered to be totally correct. Besides unemployment, there are many other factors that affect gross domestic product and gross national product of a nation. Economists agree that there is an inverse relationship between unemployment rate, and GNP and GDP of an economy, but the extent to which they are affected still varies. Many studies revolving around the relationship of unemployment and production consider a wider set of variables such as the size of the labor market, working hours of employed workers, and workers productivity rates, etc. used in the labor market. This is done so as to measure the effects the labor market has, on GDP and GNP. Further, the researchers found that the unemployment change for every 1% leads to more volatile changes in the rate of production as compared to Okuns law.
Academic Research on Okun's Law