Employment will rise as long as growth in real gross domestic product (GDP) outpaces growth in labor productivity. The unemployment rate will fall if employment growth outpaces labor force growth.
Is a higher GDP associated with reduced unemployment?
The COVID-19 epidemic has caused cities and regions across the United States to shut down. Many states have issued or are considering issuing stay-at-home orders, which require most non-essential businesses to close and citizens to stay at home. These measures are intended to delay or halt the spread of COVID-19 by limiting inter-person interaction and thereby minimizing exposure and infection risks. The production of the US economy will drop drastically as most non-essential firms close, and the unemployment rate will rise dramatically. Jobless claims are already pouring in from all around the country.1
Is it really that bad? We’ve seen various estimates of negative GDP growth rates and jobless rates that have skyrocketed. One of the most recent projections comes from Goldman Sachs, which is downgrading the GDP growth rate from 24% to 34%, with a 15% unemployment rate. 2 Because these numbers are unprecedented, it will be difficult to impose discipline on them, based on past experience.
By merging data from the Bureau of Labor Statistics (BLS) and the Bureau of Economic Analysis, this essay aims to discover a link between GDP growth rates and unemployment rates (BEA). The BLS’s employment requirement table gives a thorough estimate of the number of employees necessary for each industry or sector to produce $1 million in output. In addition, the BEA publishes a breakdown of GDP across several sectors and industries. As a result, we can calculate a link between the GDP growth rate and unemployment rates using the BLS employment database and the BEA’s industry-level GDP. The GDP in the second quarter of 2019 was used to make this calculation.
The closure of the economy has had little impact on some industries and sectors. Assume that the outputs of these sectors remain unchanged from those of 2019. Agriculture, government, housing, hospitals, and grocery shops are among these industries (such as supermarkets). These industries contribute for 30% of overall GDP in the United States.
Furthermore, certain industries are more labor-intensive than others, implying that the quantity of labor required to create the same amount of output is higher in some industries than in others. As a result, if the GDP loss comes from more (less) labor-intensive industries, the unemployment rate is higher (lower). As a result, there are upper-bound (blue line) and lower-bound (red line) estimates of unemployment rates conditional on the GDP growth rate being reduced, as seen in the graph. The upper bound assumes that the decline in GDP (represented on the x-axis) moves from the most labor-intensive to the least labor-intensive sectors. The lower bound, on the other hand, assumes the inverse.
Given that the unemployment rate in the second quarter of 2019 was around 3.6 percent, both lines begin with unemployment rates of 3.6 percent, assuming that GDP remains constant. If all output from these afflicted industries disappeared (up to 70% of GDP), the jobless rate would skyrocket to 76 percent. If the GDP growth rate is 34 percent, Goldman Sachs’ estimated unemployment rate appears to be low, according to this computation. More specifically, the unemployment rate should be between 26% and 51%, resulting in a GDP decrease of 34%.
My computation aims to bring some order to the wild forecasts of future GDP and jobless rates. Obviously, there are various drawbacks to my calculation. First, it is predicated on the premise that some industries, which account for 30% of GDP, will remain unaltered. Some firms’ employment or output (for example, grocery stores or Amazon) may be increased as a result of the economic shutdown. Furthermore, there are a slew of variables that could skew this estimate, perhaps lowering the unemployment rate. Because companies expect a speedier rebound in the third quarter and do not want to lose their workers, it is quite likely that the unemployment rate will respond slowly to the steep decrease in GDP. The extension of unemployment benefits (as authorized by Congress) could, on the other hand, stimulate layoffs and raise the unemployment rate.
What is the link between unemployment and the Gross Domestic Product (GDP)?
Because a fall in GDP is mirrored in a decrease in the rate of employment, GDP and unemployment rates are frequently linked. Increased GDP levels produce an increase in consumer demand for goods and services, which leads to an increase in employment levels.
Is employment good for the economy?
By increasing GDP, creating jobs benefits the economy. When someone is employed, they are compensated by their employer. As a result, they have more money to spend on food, clothing, entertainment, and other things. The more money a person spends, the higher the demand. Companies boost their output to fulfill growing demand for a product or service when demand rises. Companies achieve this by increasing their investment and hiring more employees. More workers enter the cycle, resulting in even more money being spent in the economy, further increasing demand.
How does raising GDP help to reduce unemployment?
Jordan is short on natural resources, although the rest of Middle Eastern countries have plenty of oil, gas, and other minerals. One of the key causes for Jordan’s low GDP is a scarcity of resources. Jordan’s low GDP is also due to low national income and limited investment as a result of high tax rates. When the unemployment rate is reduced, the economy will be operating at full capacity, and it will be powerful as consumption and purchasing power increase.
Jordan has a large population and is one of the most educated countries in the area, particularly among the youth. The most important reasons for unemployment are: first, the young Jordanians have been educated in a field that does not match the demand for labor in the market (supply of labor cannot respond to the demand for labor), second, the high ratio of foreign labors working at the minimum wage (which reduces the demand for local labor), and third, the public sector’s weakness and lack of public investment.
The relationship between economic growth and unemployment reveals that the rate of economic growth and the reduction in unemployment rates are highly correlated. An rise in the growth rate leads to an increase in employment or a decrease in unemployment. The relationship between economic growth and unemployment has been explored empirically in the economic literature based on the Okun law, which states that the change in the growth rate (GDP) and the change in the unemployment rate are inversely related. Okun has demonstrated the existence of a reciprocal relationship between unemployment and economic growth. He discovered that if unemployment fell by 1%, it was owing to a 3% increase in real gross domestic product (RGDP), and vice versa, with an increase in RGDP resulting in an increase in employment.
Economic growth is the primary goal of governments, as it is a measure of wellbeing, living standards, and poverty reduction. Using Okun’s law, certain research have empirically explored the relationship between economic growth and unemployment. Al-Habees employed a simplified model of Okun law to investigate the relationship between unemployment and economic growth in different Arab nations, with Jordan as the major case study. The findings revealed a substantial relationship between growth and shifting unemployment rates, as well as the effectiveness of economic strategies aimed at reducing unemployment while maintaining a balanced pace of economic growth. In addition, Kreishan, using Okun’s law and Augmented DickeyFuller (ADF) for unit root over the period 19702008, discovered that a lack of economic growth in Jordan does not explain the unemployment phenomenon.
Using ECM and ARDL Johansen cointegration tests, Akeju and Olanipekune investigated the Okun’s law in Nigeria to analyze the linkage between unemployment and economic growth, resulting in a notable linkage between unemployment and economic growth.
Between 1994 and 2010, Abdul-khaliq examined the relationship between unemployment and GDP growth in nine Arab countries. He discovered that growth had a notable negative effect on unemployment rates, as well as a positive association between population growth and unemployment rates. Rahman investigated the association between GDP, GDP per capita, literacy rate, and unemployment rate in OECD countries and discovered that GDP, GDP per capita, literacy rate, and unemployment rate are not significantly associated.
Using simple linear regression, Khrais and ve Al-Wadi investigated the relationship between economic growth and unemployment in MENA nations from 1990 to 2016, finding a weak correlation between the variables. Alawin used the ADF test and Johansen’s co-integration to show the link between the trade balance and the unemployment rate in Jordan over a thirteen-year period from 2000 to 2012, and he understood that a decline in the trade balance can increase the unemployment rate, and unemployment can have a negative effect on the trade balance in the short-run.
Nageld looked into the relationship between GDP growth and unemployment and discovered that the two have a negative relationship. Furthermore, Ahmed used OLS to examine the relationship between unemployment rate and growth rate in selected SAARC countries (Bangladesh, Bhutan, India, Pakistan, and Sri Lanka) from 1990 to 2010, and discovered a sign of the correlation between the economic growth rate and unemployment rate differs between the SAARC countries.
Following that, Ali and Allan stated that, from 1991 to 2015, economic growth had a positive and statistically significant impact on unemployment in Jordan. Using the OLS technique, Moh’d AL-Tamimi and Mohammad (2019) investigated the impact of the unemployment rate on economic growth in Jordan between 2009 and 2016, finding that the unemployment rate (in total labor) had a negligible impact on economic growth.
Magnani aimed to extend the Solow model, which may explain unemployment as a shortfall of aggregate demand, with an increase in aggregate demand reducing unemployment and catalyzing GDP growth. From 1994 to 2017, Xesibe investigated the impact of unemployment on GDP growth in South Africa. The findings revealed that in South Africa, there is a negative relationship between unemployment and economic growth.
Finally, Ojima investigated the relationship between unemployment and economic development in Nigeria for 35 years, from 1980 to 2017, and discovered that unemployment harmed Nigeria’s economic development, with an adverse linkage between unemployment and economic development, and recommended a fiscal and monetary policy to create job opportunities in order to sustain Nigeria’s economic growth. In the long run, Dahmani discovered a negative association between the variables, whereas in the short run, there was no correlation between unemployment and economic growth in Algeria from 1970 to 2014.
What impact does GDP have on the economy?
GDP is significant because it provides information on the size and performance of an economy. The pace of increase in real GDP is frequently used as a gauge of the economy’s overall health. An increase in real GDP is viewed as a sign that the economy is performing well in general.
What is the impact of slow economic growth on unemployment?
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When the economy grows slowly, unemployment rises, according to a long-held economic concept. In the early 1960s, economist Arthur Okun demonstrated that for every percentage point that GDP falls short of its potential, unemployment rises by half a percentage point. This link has remained constant over time, as shown in the graph. This pattern is especially noteworthy now, given that GDP is rising slowly in comparison to earlier years in the recovery, when rapid growth helped to bring the jobless rate down to a 30-year low. Because of the downturn, “According to “Okun’s law,” unemployment will continue to rise until the economy recovers.
NOTE ON THE DATA: The figure assumes a potential GDP growth rate of 3.5 percent and a so-called negative growth rate of 0.5 percent “The “Okun coefficient” is a term used to describe the relationship between two variables. The graphic depicts the percentage-point change in the unemployment rate on the left axis, and (GDP growth minus 3.5) multiplied by -0.5 on the right. It’s worth noting that the two lines are very near to each other, showing that when the economy grew below its potential (or contracted, as in a recession), unemployment rose.
It’s worth noting that the last point in the graph is based on unemployment and GDP statistics from the first quarter of 2001. Because of the existing discrepancy between these two variables, Okun’s law forecasts that unemployment will rise another percentage point from its current level of 4.4 percent unless GDP accelerates soon.
What impact does GDP growth have on businesses?
More employment are likely to be created as GDP rises, and workers are more likely to receive higher wage raises. When GDP falls, the economy shrinks, which is terrible news for businesses and people. A recession is defined as a drop in GDP for two quarters in a row, which can result in pay freezes and job losses.
What is the primary cause of joblessness?
Unemployment caused by a demand gap is the most common cause of unemployment during a recession. When demand for a company’s products or services falls, it responds by cutting back on production, which necessitates a reduction in the workforce.
What effect does GDP have on poverty?
Growth was the major element behind the reduction of global poverty from 1990 to 2010. Developing countries’ GDP has grown at a rate of roughly 6% per year over the last decade, 1.5 percentage points faster than it did from 1960 to 1990. Despite the largest global economic crisis since the 1930s, this occurred. Following the recession, the three regions with the greatest number of impoverished people all experienced high GDP growth: East Asia at 8% per year, South Asia at 7%, and Africa at 5%. According to a preliminary estimate, every 1% rise in GDP per capita reduces poverty by 1.7 percent.
However, GDP is not always the best indicator of living standards and poverty alleviation. It is usually preferable to examine household consumption using surveys. Martin Ravallion, the World Bank’s head of research until recently, conducted 900 such surveys in 125 developing nations. According to his calculations, consumption in emerging countries has expanded at a rate of just under 2% per year since 1980. However, since 2000, there has been a significant increase. Annual growth before it was 0.9 percent; after that, it jumped to 4.3 percent.
Key Points
- The Phillips curve and aggregate demand have comparable components. The Phillips curve’s rate of unemployment and rate of inflation correlate to aggregate demand’s real GDP and price level.
- There will be an upward movement along the Phillips curve if aggregate demand rises, as it does during demand-pull inflation. As aggregate demand rises, so does real GDP and the price level, lowering unemployment and raising inflation.
Key Terms
- The Phillips curve is a graph that depicts the inverse relationship between unemployment and inflation in a given economy.
- The total demand for final goods and services in the economy at a given time and price level is known as aggregate demand.