Arthur Okun addressed the general question in a 1962 article describing the empirical relationship between real economic output and the unemployment rate. Okun was among the leading economists of his day, leaving a professorship at Yale to become chairman of the Council of Economic Advisors and then a Senior Fellow at the Brookings Institution.
Okun’s rule of thumb is generally referred to as a law even though it describes a loose relationship between output and employment that has been elaborated and expanded in subsequent decades. In its original specification, the unemployment rate falls by 1 percent with every 3 percent increase in economic output. This implies that the unemployment rate will fall to 9 percent by year’s end and that the number of new jobs will fall far short of losses in 2008 and 2009. According to the Congressional Budget Office’s January projections, the unemployment rate will trend down to an average of 10.1 percent in 2010 and 9.5 percent in 2011.
The exact relationship between growth and employment is conditioned over a range of factors, including labor productivity and labor force participation. Edward Knotek, at the Federal Reserve Bank of Kansas City, points out that “[it] is a statistical relationship rather than a structural feature of the economy.”
That relationship may change over time. In recent decades, there is reason to believe that the relationship has weakened. Of particular concern, the Kansas Fed elaborates on the phenomenon of the jobless recovery: “[These] are periods following the end of recessions when output growth resumes but employment does not grow. It is possible that the advent of jobless recoveries is symptomatic of a fundamental change in the timing of the relationship between output and the labor market. …”
In reducing the tax burden for businesses in a way that is specifically linked to job growth, the administration is adopting a policy alternative that can have a positive impact on employment. If only our fiscal situation allowed for a permanent payroll tax reduction for middle-income workers. As I described in my early December column that followed the release of the November Employment Situation report, the economy has yet to demonstrate its capacity for private payroll growth. A return to robust positive absorption depends upon the labor market’s moving past stabilization and replacing the millions of jobs that have been lost in the contraction.
I went on to state that the public sector cannot create these jobs, nor should it; a more favorable climate for private-sector job creation can and should create them. Reducing the costs associated with payroll growth, by cutting or deferring payroll taxes for net new employees, may be the most economically efficient policy option available to Washington. By extension, it is exactly the type of policy that we should expect from an administration that is serious about encouraging jobs.
Sam Chandan, Ph.D., is president and chief economist of Real Estate Econometrics and an adjunct professor of real estate at Wharton.