John Irons's Blog

Icon

Economic News, Data and Analysis

Growth and Unemployment – Okun’s Law

Okun’s law lives!

The US economy is performing nicely. The Bureau of Economic Analysis
recently
announced
that real GDP in the US grew at an annual rate of 5.5% during the third quarter
of 1999. Over the past four years real GDP growth has averaged about 4%
per year. In another piece of good news, the unemployment
rate
is near a 30 year low of 4.1%, down from 4.5% in 1998 and down
from a decade-high of 7.5% back in 1992.

The most recent experience – along with some simple logic – suggest
that there is some relation between high output growth and unemployment.
This relation is usually called Okun’s law.

Named after the economist Arthur
Okun
and first formulated in the 1960’s, the “law” captures an empirical
relation between the unemployment rate and the growth in real output. 
The relation says that the change in unemployment is given, approximately,
by

Change in Unemployment = – 0.5  *  (growth – 3%).

In other words, for every point that GDP growth is above 3%, the unemployment
rate falls by 1/2 a percentage point. (For example a 4% rate of growth
in GDP would lead to a reduction in unemployment from 4.5% to 4.0% over
the course of a year).

While this “law” was formulated back in the 60’s, it has held up rather
well over time. Figure 1 shows how nicely this
relation has held up over the period from 1959 to 1998.

For the past three years, unemployment has been falling by about 1/2
percentage point per year, while growth has been around 4% — matching
Okun’s law rather well. In contrast to many macroeconomic relationships,
which are famous for their instability, Okun’s law has been remarkably
stable over time.

This relation, should it continue to hold up, may be a bit of a worry
to Alan Greenspan. As long as we are growing at such a fast rate – and
so long as Okun’s law holds, we will see unemployment falling. However,
unemployment cannot fall forever, since, at the very least, it is bounded
by zero. Either Okun’s law will have to give, or the economy will have
to slow down.

Whether this happens on its own or by the hand of Mr. Greenspan is still
up in the air, although the recent interest rate hikes indicate that the
latter scenario is likely.

 

 

Figure 1.

Side Note: Okun’s law is more generally given by:

Change in unemployment = – a (growth – b).

Figure 2. shows the more general relation and suggests that rather
than have a=0.5, we should have a=0.35. Either way, the relation
holds up nicely over time.

 

Figure 2.

More Features

Comments? Post in the Forum.

Data Sources: Department
of Labor
,
NIPA,
BEA,
and author’s calculations. Figures created by the author.

Filed under: Data, Economy, Recession

WTO – The Movie

Who says there’s nothing good on TV?

I’ve been watching this great mini-series on television for the past
several nights. It’s a Star Wars meets The X-Files extravaganza!

It has a fantastic cast of characters and a great plot. The story centers
on a mysterious group of powerful leaders who have a habit of meeting behind
closed doors and who are believed (although falsely) to be able to over-rule
laws in any country with the stroke of a pen. Fighting this group are the
band of ragged forces who have put aside their past differences and have
united to fight this common enemy.

There is also a town mayor apologizing for the police. There are anarchists
who just can’t wait for that cup of coffee and have to go through the front
window of the local Starbucks. There is that French guy who hates BigMacs
who decided to make Seattle’s McDonalds his next victim – he couldn’t have
found one closer to home? There is a president trying to invite the protesters
inside, (although he does sound a bit like someone who ran into an acquaintance
on his way to a party, “Oh, you’re invitation must have been lost in the
mail.”) There is the reform party presidential candidate who is trying
hard to resist saying “See, I told you so,” more than 50 times a day. Add
confused delegates, riot gear, a couple hundred journalists, and (my personal
favorite) one thousand sea turtle hats.

My popcorn’s popping – it’s almost time for the news!

Ok, I feel slightly bad about making light of the situation – there
are high stakes all around. But, it was either this or become the 243,563rd
economist to explain why Free Trade is Good – and since you are lurking
around the internet looking for economics rather than for the newest video
game strategy
or some dating advice,
I am assuming that you know the basics of comparative advantage.

We’ve got issues

There are myriad serious economic and social issues surrounding free
trade and “globalization” in general and tons of more minor problems when
it come to the World Trade Organization (WTO).

The millions of dollars in lost holiday business suffered by downtown
seattle are a drop in the bucket when compared to the potential gains from
trade which would result from reducing barriers across countries. Any cases
of excess force by the police are a mole hill when compared to the mountain
of suffering by workers and children in sweatshops. And, the canisters
of smoking tear gas (which make for great pictures on TV) are a fine representation
of the smog choking many of the world’s largest cities.

I sympathize both with the free trade side as well as with (most of)
the protesters, and I believe that there is common ground to be found.

It’s not about trade

Free trade is only a catalyst – it only magnifies the problems that
already exits. There are two primary complaints that have cropped up at
the protests: 1) free trade in general, and the WTO in particular, is harmful
to the global environment, and 2) free trade is harmful to the workers
of the world who are not protected by reasonable labor standards.*

[*There is also an segment that points out the free trade hurts groups
of U.S. workers – which it does do in certain industries – and that
it is therefore bad for the country – which is both a non-sequitor and
wrong. The obvious gains from trade to consumers and the fact that workers
in other countries benefit tend to make this a very dubious and mostly
nationalistic point of view.]

The real “problem” then is not free trade. For the environment, the
problem is relatively loose environmental regulations. For the workers,
the problem is relatively loose labor laws. Free trade makes these underlying
problems worse since it increases production, but trade is not the underlying
problem. Free trade is just one possible tool that environmental and labor
groups can use to try to affect change in governments that might not otherwise
be willing to listen.

As is usual, there seem to be only two sides to the debate portrayed
in the press – the protesters are labeled “Anti-trade” while the WTO is
“Free-trade”.

If we could get beyond the false front of a debate on free trade, then
maybe we can get to the real issues – such as whether it is appropriate
to insist that other countries follow certain environmental or labor standards.
And if so, what specific form should these (world?) standards take?

Well, my popcorn is ready, maybe we can talk about the real issues after
the movie is over.

More
Features


WTO
– Got to go?
Post in the Forum.

More Links

For details on the meetings and the issues discussed see the official
sites:

For all of the anti-WTO info see:

Also see:

Comparative Advantage: Very Simple Example

— Adam can make 2 hot dogs or 6 buns in an hour.

— Eve can make 6 hot dogs or 2 buns in an hour.

With 2 hours till the super bowl starts…

No Trade:

Adam makes 3 hot dogs (1.5 hours) and 3 buns (0.5 hours) = 3 hot dogs/buns.

Eve makes 3 hot dogs (0.5 hours) and 3 buns (1.5 hours) = 3 hot dogs/buns.

With Trade:

Adam makes 12 buns (2 hours).

Even Makes 12 hot dogs (2 hours).

They trade 6 buns for 6 hot dogs, and they each eat 6 hot dogs.

With trade, consumption is twice as much as with no trade.

The same logic holds for countries in addition to biblical characters.

 

Filed under: International

Pages

Archives