Imperfection in Okun's Law
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Written by: arkylmarzers
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Date: Mon, 31 Oct 2011 |
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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.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.
Okun's law is named after Arthur Okun, the economist who in 1962 was the first to make detailed observations about this relationship. So-called "natural unemployment" refers to the fact that there will always be at least a certain amount of unemployment in a free market economy, because of voluntary changes in employment, and other reasons not related to economic hardship.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.Many economists have observed that Okun's law is really not a law at all, but more of a tendency that can vary based on a number of factors. Although it can be expressed mathematically, and holds up under real-world scrutiny, Okun's law is an imperfect theory. This is not as a result of any error on the part of Okun the economist, but rather because of unpredictability. For example, the exact amount of unemployment that constitutes natural unemployment is not known, nor can it be.
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Source: Imperfection in Okun's Law
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