Arthur Melvin “Art” Okun, born November 28, 1928 in Jersey City, New Jersey – was an American economist. He served as Chairman of the Board of Financial Advisors between 1968 and 1969. Prior to his chairmanship of CEA, he was a professor at Yale University. He formulated Okun’s law on the relationship between unemployment and economic growth.
The American economist Arthur Okun formulated a law – Okun’s law – which states that there is a clear negative correlation between GDP growth (measured in %) and the absolute change in the unemployment rate. This means that when GDP rises, the unemployment rate will fall. Okun’s legislation claims that for every percentage point, the actual unemployment rate exceeds the so-called “natural” unemployment rate, the gross domestic product is reduced by 2-3%.
Okun’s law is more defined as “Okun’s rule of thumb”, because it is primarily an empirical observation rather than a result derived from theory. Okun’s legislation is approximate because factors other than employment (such as productivity) affect production.
There are several reasons why GDP may rise or fall faster than unemployment falls or rises. The following happens when unemployment rises,
- A reduction in multiplier effect, created by circulation of money from employees
- Unemployed people can quit the workforce (stop looking for work), after which they are no longer counted in the unemployment statistics
- Employees can work fewer hours
- Labour productivity may fall because employers retain more workers than they need
One of the consequences of Okun’s legislation is that an increase in labor productivity together with an increased labor force may mean that net real value output grows without net unemployment falling.
If the following applies:
Y = GDP
U = unemployment rate
C is the factor that relates to changes in unemployment to changes in output
ΔY is the change in actual production from one year to the next
ΔU is the change in actual unemployment from one year to the next
K is the average annual growth rate at full employment
Okun’s law can be formulated as follows:
ΔY / Y = K – CΔU, which can be rewritten to
ΔU = (K – (ΔY / Y)) / C
Where K is the average growth rate and C is the factor that links the change in unemployment to the growth in GDP. For example, if K is 2%, the growth rate must be greater than 2% for unemployment to fall. How much unemployment falls will depend on C.