Keyboard Cat plays off Okun’s Law

I’ve been teaching Okun’s Law in my principles level Macroeconomics courses since 1980. It’s been the policy rule of thumb since the Kennedy years on how much GDP needs to change to get a movement in the unemployment rate. Here’s the Wiki explanation which is as good as any.

In economics, Okun’s law is an empirically observed relationship relating unemployment to losses in a country’s production. The “gap version” states that for every 1% increase in the unemployment rate, a country’s GDP will be an additional roughly 2% lower than its potential GDP. The “difference version” describes the relationship between quarterly changes in unemployment and quarterly changes in real GDP. The accuracy of the law has been disputed. The name refers economist Arthur Okun who proposed the relationship in 1962 (Prachowny 1993).

I’ve mentioned recently that we’re seeing some fundamental changes in that relationship. This WSJ article talks more about how we’re breaking away from the historical pattern studied by Okun back in the 1960s. This has incredible ramifications for fiscal policy makers. Again, I think the Obama economic advisers appear to be ignoring some really important changes in the fundamentals. We’re much more oriented towards imports, service jobs, and capital than we were back in the Camelot days.

Breaking from historical patterns, the unemployment rate — currently at 9.5% — is one to 1.5 percentage points higher than would be expected under one economic rule of thumb, says Lawrence Summers, President Barack Obama’s top economic adviser. Since the recession began in December 2007, the economy has lost 6.5 million jobs, 4.7% of total employment. The unemployment rate has jumped five percentage points, while the economy has contracted by roughly 2.5%.

We’re seeing more and more ‘jobless’ recoveries. There are some basic reasons why employers appear to be reluctant to hire even when the economy appears to be doing reasonably well, like it was earlier this decade.

Though today’s disparity between growth and jobs is especially stark, a jobless recovery wouldn’t be new: The past two recessions were marked by firms reluctant to resume hiring right away after demand recovered. The current disconnect could reflect an unanticipated surge in productivity — companies finding ways to increase output with fewer workers. That could set up the economy to grow rapidly in future years. Rising productivity is the linchpin of economic growth and rising living standards.

There are some relatively good reasons for this. First, we’ve seen the wholesale move of manufacturing jobs to

The trajectory is still DOWN for Jobs

countries with lower costs, lower pollution standards, and lower regulation. Until we quit encouraging this with our tax structure and laws, I can’t imagine any profit seeking multinational reversing course. Automobile manufacturing plants have even headed north to Canada where they can avoid providing health care benefits to unionized workers. We basically encourage many companies to take what used to be good blue collar jobs elsewhere. Also, American workers, when frightened of job loss, will increase productivity. We work longer hours and take less sick days and vacation days than just about any other batch of workers in the industrialized world. This lets employers gear up production without additional workers. If you look at all the recent data, you’ll see that while productivity in this country has increased, the portion of those productivity gains going to workers has fallen. A greater share of productivity gains now go to capital. I don’t see this trend changing any time soon.

Still, 70% of expenditures on our GDP come from households. If they can’t borrow, dis-save, or count on real wage increases to support their spending, how can we expect our economy to grow? It won’t come from investment because you don’t buy new plant and equipment if you don’t expect new sales and we still have yet to see the coming readjustments in the commercial real estate market. We’re going to be severely under-capacity shortly in terms of building infrastructure. In several states, there are already empty shopping centers, factories, and malls.

That increased demand for GDP will not come from exports either. We continue to be reliant on cheap junk pouring in from places like China. That still leaves us with the remaining component of GDP, government. States with balanced budgets cannot spend more than they bring in, and they will be bringing in less and less as tax revenues fall. So, do the math. There’s really only one remaining place for increased spending to come from and that’s the Federal government Because of the botched first stimulus, we now have fewer and fewer folks willing to give a second stimulus a chance.

Sixty percent (60%) of U.S. voters now oppose the passage of a second economic stimulus plan this year, a five-point increase in opposition since the issue was first raised in March.

A new Rasmussen Reports national telephone survey shows that just 27% of voters favor a new stimulus plan, unchanged from the earlier findings. Thirteen percent (13%) are not sure.

The administration however, appears to holding its cards and betting that the first stimulus plan will still come through. In that same WSJ article, Summers says give it six months. Yeah, that’s just enough time for every one’s unemployment insurance to run out and for many folks to go from unemployed to discouraged worker. Discouraged workers do not count in the unemployment rate.

For now, administration officials are taking a wait-and-see approach, and they insist they have no plans to push new measures to counteract job losses. Officials say the $787 billion economic-stimulus package will have a bigger impact over the next six months.

The “two-year program that we put in place was one that had gathering and increasing force over time,” Mr. Summers said in an interview

Again, this breakdown of what was a fairly stable relationship between GDP growth and job growth has many interesting implications. Not only for fiscal policy makers, but monetary policy makers also.

The disparity between the job market and economic growth has other important implications. For Fed officials, it implies that there will be little upward pressure on prices and wages — in other words, little inflationary pressure — giving officials reason to hold off on raising interest rates any time soon.

Employers’ unusual behavior seems to have intensified as the economy has stabilized. When the government releases its estimate of second-quarter gross domestic product next week, economists expect it will show a contraction of less than 2% at an inflation-adjusted annual rate. During the same three months, employers cut payrolls at an annual rate of more than 4%, eliminating 1.3 million more jobs.

I’m going to go out on a limb here and say that I believe we will see more corrections before this is all over and that the Fall (a traditional time for stock market corrections) will see another dip. Maybe you can all disabuse me of the notion by telling me you’re going to spend like crazy over the crass consumerism holiday season. Other than that, I just don’t see where any upturn is coming from. I only see problems in the commercial real estate market and problems for retailers ahead.

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