A slight digression from talking about the budget. Today the Irish Times reported that the recession was over. By this they meant that economic activity as measured by GDP had started to rise again in the first quarter of this year. The question is when will we begin to feel this rise. In particular when will unemployment (currently just below 14%) start to fall? Or will we be in for a period of protracted “jobless growth”.
In fact the link between growth of GDP and unemployment has long been discussed in economics. The link is known as Okun’s law. Like most economic “laws” it is not really a law at all. It is not something that must hold, it is just a relationship observed in the data — and one that appears to hold most of the time.
The graph above shows Okun’s law for Ireland. As can be seen there is a negative relationship between growth and unemployment. As growth rises, unemployment falls. The solid line indicates the average extent of that relationship. Historically, on average, a fall in the unemployment rate of one percentage point would usually require growth to rise by 1.11 percentage points. However, this is only the average relationship. As the scatter plot indicates there have been some years of high growth and little change in unemployment and vice versa
So we clearly have to be wary of making forecasts on the basis of the average relationship when there has been considerable variation on either side of that relationship over the last few decades. Nevertheless the average relationship provides a reasonable starting point for such a forecast. So what would need to happen (according to Okun’s Law) if we are to get unemployment down from the current level of 14% to a more respectable level of 6%? According to Okun’s law an 8% fall in employment would require growth of 6% every year for 5 years. This is a tall order at the best of times. It will only be possible if week keep domestic costs under control and if the world economy rebounds strongly. Failing that, we could be in line for an extended period of jobless growth.
