Measuring Unemployment

Will The Old Okun's Law Help to Assess the Economic Impact of COVID 19?

If So, Will GDP Dip by Double Digits?

In 1962, an American Economist from Yale University, Arthur Okun, did an empirical study and proved there was a negative short-run relationship between the unemployment rate and real GDP. Many studies subsequently confirmed Okun’s findings and referred to the phenomenon as “Okun’s Law, ” which became a staple in many macroeconomics textbooks. (Okun also served as the chairman of the Council of Economic Advisers between 1968 and 1969 in the Johnson administration.)

Specifically, Okun’s law says an increase of a country’s unemployment rate of 1% will cause its GDP to dip 2%.
With COVID-19, the unemployment rate has escalated from 4.4% in early March to approximately 16% in mid-April. It will likely remain at the high level at least through the second quarter of this year.

If so, based on Okun’s law, the real GDP will dip by 23.6% during Q2 2020. (Using the formula, 2% X (16-4.4%) = -23.6%.)

Real GDP May Decline

If, as some experts believe, the unemployment rate is actually higher than 16%, possibly 20% or more as discouraged workers and ongoing applicants are excluded from the number, the real GDP may decline by 27.6% or more. In 1932, the worst year of the Great Depression of 1929, the unemployment rate was 23.60% and real GDP declined 12.90% incrementally from the previous year. In 2009, the worst year of the Great Recession of 2008, the unemployment rate was 10% and real GDP declined 4%.

Whether the current Pandemic is a long-term Depression or a short-term Recession depends on how soon we can contain the coronavirus and when the economy will reopen in a significant way. Each recession and depression is different. With a digital economy, we certainly don’t expect to have a long-term depression, but the magnitude of this pandemic recession can certainly be called a short-term depression in its own category.

Okun's law says an increase of a country's unemployment rate of 1% will cause its GDP to dip 2%...

That means GDP will be in severe negative territory for a significant period of this year, a potential travesty for the U.S. economy and all Americans. In the meantime, the unprecedented stimulus package should expedite the recovery by providing liquidity to the most damaged sectors of the economy – travel/tourism, state/local governments, and small/medium companies.

 

 

 

About Tenpao Lee, Ph.D.
Dr. Lee is a full professor of economics at Niagara University. He earned his Ph.D. in economics from Iowa State University. He was a Fulbright Scholar to Taiwan in 2001 and a Fulbright Senior Specialist from 2002 to 2009. In 2013, Dr. Lee was named as a Distinguished Visiting Research Fellow by Jianghan University in Wuhan, China. In 2015, he was awarded the title of “Shanghai Distinguished Oversea Professor” by the Shanghai City Government, China. In addition to business statistics, Dr. Lee has taught supply chain management at both the undergraduate and graduate levels. He also developed a study abroad program to Asia that includes China, Taiwan and Japan. Dr. Lee’s research focuses on the impact of globalization on the economy. He was the editor of the International Journal of Intellectual Property Management.
Niagara University
Founded by the Vincentian community in 1856, Niagara University is a comprehensive institution, blending the best of a liberal arts and professional education, grounded in our values-based Catholic tradition. It’s colleges of Arts and Sciences, Business Administration, Education, and Hospitality and Tourism Management offer programs at the baccalaureate, master’s and doctoral level.