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Okun’s Law

Okun's Law

Okun's law reflects the idea that there is a regular relationship between changes in a country's unemployment rate and changes in its economic growth rate.

Okun's law states that there is a regular relationship between changes in a country's unemployment rate and changes in its economic growth rate. For example, as originally observed in 1962 by Arthur Okun, an American economist who was a member of the Council of Economic Advisors, GDP growth must be two percentage points faster than its current rate to secure a 1% fall in unemployment. The reverse is also the case: Okun's law suggests that when unemployment is higher than the natural rate of unemployment (necessary unemployment that occurs in all economies, even healthy ones), GDP growth will be below its potential rate. Okun's law posits that growth means increased production and a need for more labor, which results in lower unemployment.

Okun's law is often described as a rule of thumb. However, Okun's law is useful in drawing attention to the extent to which policies to stimulate economic growth can promote employment. If ensuring that the economy is growing as fast as possible can achieve full employment—when all people in an economy who want a job are able to get a job; that is, all unemployment is cyclical—then there may be no need for other job-creation policies. On the other hand, if as-fast-as-possible economic growth produces an insufficient increase in employment, there will clearly be a need for policies aimed at tackling structural employment among target groups such as youth or minority groups.

A number of economists have conducted research to verify or disprove Okun's law. They found the law to have general validity, although the relationship between changes in GDP and changes in unemployment were different from country to country. For example, research shows that the effect of economic growth on cyclical unemployment is much stronger in North America than in Japan. Countries have different job structures that influence their ability to grow economically. The United States has a large, diverse job market with many industries. Smaller economies, such as Japan, are focused on a few industries, such as technology, so economic growth cannot impact cyclical unemployment as strongly as other, more diversified economies. When a country has only a few industries, other influences, such as technological trends, may also impact growth.
GDP growth and unemployment are plotted along two axes, showing the correlation between the two. Okun's law states that changes in a country's unemployment rate correlate inversely with changes in GDP. In other words, every 1% increase in unemployment is associated with a 2% decrease in GDP. Okun's law has been supported by data since its development in the 1960s.