The using Okuns law to track and analyze the changes in the unemployment rates over the last decade - Research Paper Example

?Topic: Use Okun’s law to track and analyze the changes in the unemployment rates over the last decade Output and employment have a tendency to more simultaneously. In 1962, Arthur Okun conducted an empirical research over the relation between changes in unemployment to the changes in gross national product in US economy. He found that for every 3 percent increase in real output of the country, unemployment decreased by 1 percent. The observers of this result started to dub it as “Okun’s Law”. Thus for the United States, Okun coefficient is 3. It can logically be expected the output of a country to approximately move one for one with the level of employment. Okun, however, argued that Measures unemployment is less volatile to any economic change than output. This is for, according to him, fluctuations in working hours and labor force participation generally hide underemployment to some extent. (Okun, 1962). Okun coefficients are not same for all countries. It has been found by the economists that most of the developed or industrialized nations of the world have higher Okun coefficients than United States. It simply implies that, in most of the other industrialized nations of the world the rates of unemployment have a tendency to vary less for a given fluctuation in gross domestic product than in case of the United States. A reason for this could be that in United States labor market is less regulated than in other countries and hence companies can more easily lay off their workers during economic slowdowns. In most of the industrialized countries, there are stronger implicit job protections by the societies, stronger unions, and higher governmental restrictions on laying off workers than in United States. (Kaufman, 1988; Moosa, I. A.(1997) However, over the years, many industrialized countries have undertaken various reform measures to reduce restrictions on labor market so that companies can exercise more freedom in laying off workers at the time of economic downfall. Thus, Okun coefficients of many industrialized countries like UK, Canada, Germany, Japan, France and so on have been lowered in recent time than before. However, USA still has the largest Okun coefficient. (Kaufman, 1988; Moosa, I. A.(1997) One interesting thing about Okun coefficient is that it can change over time as the relationship between output growth and change in unemployment depends to a large extent on a number of other factors like technology, social regulations, demographics, laws, etc. As these factors change, Okun coefficient might also change. (Lee, 2000). Here this Okun’s law will be used to analyze the movement in the rate of unemployment in US over the last decade. Here an attempt will be made to find out whether Okun coefficient is still the same in US as documented by Arthur Okun. The last decade has experienced huge economic fluctuation, and hence it would be quite interesting to find out the value of Okun coefficient under such economic slow down in US. At present, most of the economies throughout the world are going through a critical phase of recession and among all the economies. The situation has been so critical that the most power economies in the world also have not been able to escape this economic crisis. Economies of U.S., Japan, China, U.K. etc are all suffering from severe demand crunch and consequently fall in production and employment. U.S. is the Worst hit country by the current recession. The ongoing economic crisis through out the whole world owes it origin in U.S. following a huge credit crisis in the home loan market. Since early 2008, the U.S. economy has been looming under recession. Many economists are even of the opinion that this recession has started during the last quarter of 2007 itself. The effect of recession has not been confined to U.S. economy only. In late 2007 and even early 2008, most of the stock market indices across the world were touching the sky. Under such scenario, corporate houses were showing over enthusiasm and in several of countries money was flowing in huge amount. There was signal of the greed of making more and more profit all over. All these incidents, however, were also providing some signals that in near future over exuberance and greed would ultimately put a halt in the dream run of the economies. In early 2008, these signals ultimately came to life with the prediction of IMF regarding deteriorating growth of economy. (Foldvary, 2008; Recession 2008 ) U.S.A has always been a dominant economic power in the world and it accounts for approximately 21 percent of the world economy. The changing economic scenario, particularly since early 2008, had pointed towards a recession in U.S. economy. U.S. economic recession was held responsible for the global economic downturn as U.S. economy always influences economies of other countries in a major way. A number of countries, particularly the developing countries of the world are hugely dependent on U.S.A. and hence, economic slowdown in America brought about bad fate for the economies of these countries also. Since the early 2008, the demand of consumers in U.S.A. have started to reduce drastically as a result of which demand for imported items have also declined significantly which in turn have negatively affected the economies of those countries whose economies are largely dependent on the exports of the goods and services to America. (Recession 2008) The major factors that have caused this huge economic downturn in U.S.A. and other countries include soaring oil prices and a huge credit crisis. The effect of recession is being largely felt in most of the major and supposedly strong economies in the world. The economies of U.S., Japan, and a number of European countries are suffering the most. Most of the economic sectors are facing excessive domestic as well as international demand crunch. There has been huge fall in domestic demand as well as in exports. Under this recessionary situation, the level of employment has decreased to a large extent all over the world. The fall in employment has easily been translated into a fall in real income thereby causing fall in demand for consumption goods. In U.S.A around 1,57,000 job were lost in 2008. Jobs cut has become common in other countries too as most of companies have been adopting the process of cost cutting for surviving in this critical economic situation. A number of developed as well as developing countries are suffering from very low G.D.P and declining growth of economy. The whole world has also been experiencing severe credit crunch. (Foldvary,2008) Under this kind of drastic situation, it would be quite interesting to find out the value of Okun coefficient. For the convenience of analysis, only unemployment movement of United States will be taken under consideration at this time. Data of rate of unemployment and real GDP growth will be collected to find out the how unemployment rate has changes over the last decade with change in real GDP. Okun has expressed the relationship between change in unemployment and output growth in the following simple form. Change in unemployment = a – b ?change in real output. Here a is the intercept term and b is the elasticity of the rate of unemployment to the change in real output. Okun estimated that the value of b was equal to 0.3 in United States at the time of early post- World War II era.1 Table 1 presents the unemployment rates and changes in unemployment rates over the last decade. Table 1: Unemployment rates and changes in unemployment rates during 2000-2010 year unemployment rate change in unemployment rate 2000 3.967 -5.93% 2001 4.742 19.54% 2002 5.783 21.95% 2003 5.992 3.61% 2004 5.542 -7.51% 2005 5.083 -8.28% 2006 4.608 -9.34% 2007 4.608 0.00% 2008 5.817 26.24% 2009 9.275 59.45% 2010 9.73 4.91% The table shows that in early 2000s, the rate of unemployment increased over time. However, at the middle of the last decade the unemployment rate decreased continuously for three years. However, since 2008, the rate of unemployment increased drastically on account of global recession. However, in 2010, the extent of increase in the rate of unemployment has been lowered. Table 2 presents the real output growth rates and changes in output growth rates over the last decade. Table 2: real output growth rates and changes in output growth rates during 2000-2010 year real GDP growth rate change in growth rate in real GDP 2000 4.139 -14.24% 2001 1.08 -73.91% 2002 1.814 67.96% 2003 2.49 37.27% 2004 3.573 43.49% 2005 3.054 -14.53% 2006 2.673 -12.48% 2007 1.947 -27.16% 2008 0 -100.00% 2009 -2.633 -Infinity 2010 2.639 -200.23 % The table shows that since the very beginning of the decade, the rate of real output growth decreased over time. However, at the middle of the last decade the real output growth rate increased continuously for three years. However, since 2005, the rate of real output growth decreased drastically on account of global recession. Now in order to find out the Okun coefficient a simple regression will be run using the formula of Okun’s law in order to analyze and track unemployment in last decade. Table 3 presents the results for regression: Table 3 SUMMARY OUTPUT Regression Statistics Multiple R 0.641448 R Square 0.411456 Adjusted R Square 0.346062 Standard Error 16.91548 Observations 11 ANOVA   df SS MS F Significance F Regression 1 1800.341 1800.341 6.291965 0.033399 Residual 9 2575.2 286.1334 Total 10 4375.542         Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 2.909435 5.739525 0.506912 0.624403 -10.0743 15.89315 -10.0743 15.89315 X Variable 1 -0.13014 0.051883 -2.50838 0.033399 -0.24751 -0.01277 -0.24751 -0.01277 Thus the Okun coefficient for US economy over last decade was equal to -0.1 (approximately) that is lower than the coefficient calculated by Okun in early post- world War period, -0.3. This result simply implies that unemployment has become relatively more responsive to change in real output. Hence, in this economic downturn, the US economy has suffered huge loss the employment due to loss in real GDP. Thus it has been found that over the last decade unemployment of US has been significantly dependent on real output growth. References: 1. Okun, A. M. (1962). ‘‘Potential GNP: Its Measurement and Significance.” In: Proceedings of the Business and Economic Statistics Section of the American Statistical Association. 2. Alexandria, V. A: American Statistical Association. 2. Kaufman, R. T. (1988). An International Comparison of Okun’s Law.’ Journal of Comparative Economics, 12(2), pp. 182-203. 3. Moosa, I. A.(1997). “A Cross-Country Comparison of Okun’s Coefficient.” Journal of Comparative Economics, 24(3), pp. 335-56. 4. Lee, J. (2000). “The Robustness of Okun’s Law: Evidence from OECD Countries.” Journal of Macroeconomics, 22(2), pp. 331-56. 5. Mumbai Space. Recession 2008. Available at http://www.mumbaispace.com/economics/recession-2008.htm[Accessed on 14th March, 2011] 6. Foldvary, F. (2008). E. The Depression of 2008. The Gutenberg Press. retrieved on march 23, 2009 from: http://www.foldvary.net/works/dep08.pdf Read More