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.
What is the connection between GDP and the unemployment rate?
Okun’s law examines the statistical relationship between unemployment and economic growth rates in a country. According to Okun’s law, a country’s gross domestic product (GDP) must expand at a pace of around 4% for one year in order to achieve a 1% reduction in unemployment.
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 happens to real income when real GDP rises?
Finally, evaluate the consequences of a rise in real gross domestic product (GDP) (GDP). Such an increase indicates that the economy is growing. As a result, looking at the implications of a rise in real GDP is the same as looking at how interest rates will change as a result of economic expansion.
GDP may rise for a variety of causes, which will be examined in more detail in the next chapters. For the time being, we’ll assume that GDP rises for no apparent reason and explore the implications of such a development in the money market.
Assume the money market is initially in equilibrium with real money supply MS/P$ and interest rate i$ at point A in Figure 18.5 “Effects of an Increase in Real GDP.” Assume, for the sake of argument, that real GDP (Y$) rises. The ceteris paribus assumption states that all other exogenous variables in the model will remain constant at their initial values. It means that the money supply (MS) and the price level (P$) are both fixed in this exercise. People will need more money to make the transactions required to purchase the new GDP, hence a growth in GDP will enhance money demand. In other words, the transactions demand effect raises real money demand. The rightward change of the real money demand function from L(i$, Y$) to L(i$, Y$) reflects this rise.
What is the link between job creation and economic growth?
Increased productive employment requires economic growth, which is the outcome of both increased employment and increased labor productivity. As a result, the rate of economic expansion determines the absolute limit to which employment and labor productivity growth can occur.
Is unemployment factored into GDP?
During the recent recession, the observed drop in GDP was accompanied by a larger increase in the unemployment rate than Okun’s formula predicted. With only a 0.5 percent drop in GDP, the unemployment rate increased by 3 percentage points in 2009:Q4 compared to 2008:Q4. However, according to Okun’s formula, that 0.5 percent loss in GDP should have resulted in a 1.5 percent increase in the jobless rate. In 2011, the trend is reversed: Q4: A slight gain in GDP was accompanied by a drop in unemployment that was much higher than the data’s pre-Great Recession connection would have anticipated. While the economy increased by less than 2% (green circle), the unemployment rate fell by one percentage point. Okun’s law, on the other hand, anticipated a 0.5-percentage-point increase in unemployment. The relationship between 2009:Q4 and 2011:Q4 is depicted by the red line in the first graph: A four-percentage-point increase in the unemployment rate equals a one-percentage-point drop in output. As a result, the most recent trend is substantially steeper than previous ones.
Personal Costs of unemployment
- Unemployed people’s incomes are lost. In the United Kingdom, unemployment is one of the leading causes of poverty. Long periods of unemployment can push families into debt and raise relative poverty rates.
- Homelessness is a possibility. People who lose their jobs may not be able to afford to pay their rent. Homelessness is frequently exacerbated by increases in unemployment. (BBC)
- Future opportunities are harmed. Unemployed people will have a harder time finding job in the future (this is known as the hysteresis effect)
- Human capital has been lost. People who are unemployed miss out on ‘on the job training.’ High unemployment rates can impair labor productivity, hence this is an important component of human capital and labor skills. Someone who is unemployed for two years misses out on the most up-to-date working methods and trends. Unemployment can also impact unemployed people’s confidence, making them less employable in the future.
Unemployment and depression/mental health
- Unemployment causes stress and health issues. Signs of depression, mental worry, and physical problems are significantly higher in studies of unemployed men. (Health Effects of Unemployment) (US Library of Health) “About one in five Americans who have been unemployed for a year or more say they presently have or are being treated for depression about double the percentage among those who have been unemployed for five weeks or less,” according to a Gallup research.
- Depression, substance abuse, hospitalizations to psychiatric facilities, suicide, and violence are all common effects of unemployment, according to another study. (1)
Cost of unemployment to Government
- Government borrowing has increased. Because fewer people are paying income tax and spending less, higher unemployment will result in a drop in tax revenue (hence lower VAT). In addition, the government will have to pay more on unemployment benefits and other related expenses. The government does not only give unemployment benefits; unemployed families are more likely to obtain housing assistance and financial support. According to one estimate, the cost of one person being unemployed to the Treasury is 6,243 per year in benefits and lost tax revenue. (Independent)
Costs of unemployment to society
- The economy’s GDP will be lower. High unemployment shows that the economy is underutilized and inefficient, resulting in decreased output and earnings. Unemployed people are also unable to acquire as many things, resulting in lower expenditure and productivity. Unemployment increases might have a negative multiplier effect.
- An increase in social issues. Crime and vandalism are more common in areas with significant unemployment (particularly among teenagers). It can lead to alienation and make it harder for young unemployed persons to integrate into society.
- Instability in politics. In the 1930s, there was a period of enormous unemployment, which resulted in social upheaval. The ascent of Hitler and the Nazi party in Germany was aided by a 6 million-strong jobless rate.
In the United Kingdom, periods of high unemployment intensified poverty, isolation, and inequality.
- In 2012/13, welfare spending (unemployment, Job Seekers Allowance) totaled 5 billion.
What factors boost real GDP?
The value of economic output adjusted for price fluctuations is measured by real gross domestic product (real GDP) (i.e. inflation or deflation). This adjustment converts nominal GDP, a money-value metric, into a quantity-of-total-output index. Although GDP stands for gross domestic product, it is most useful since it roughly approximates total spending: the sum of consumer spending, industrial investment, the surplus of exports over imports, and government spending. GDP rises as a result of inflation, yet it does not accurately reflect an economy’s true growth. To calculate real GDP growth, the GDP must be divided by the inflation rate (raised to the power of the units of time in which the rate is measured). The UNCTAD uses 2005 constant prices and exchange rates, while the FRED uses 2009 constant prices and exchange rates, while the World Bank just shifted from 2005 to 2010 constant prices and currency rates.
What is the distinction between nominal and real GDP?
Real GDP measures the entire value of goods and services by computing quantities but using inflation-adjusted constant prices. This is in contrast to nominal GDP, which does not take inflation into account.
What happens if the economy grows?
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.
Do real GDP and employment have a positive relationship?
Employment will rise as long as growth in real gross domestic product (GDP) outpaces growth in labor productivity.