State Level Tests of Okun’s Coefficient

Abstract

Okun’s Coefficient states that there is a three to one relationship between output and unemployment, a relationship that policy makers can exploit. Numerous studies conducted at the national level have confirmed the overall validity of this empirical proposition, even while calling into question some of the details. Using U.S. State level data, this paper tests for Okun’s coefficient over the period of 1977- 1997, and 1997 – 2007. This paper finds that Okun’s coefficient does exist at the state level, though it is generally lower than national U.S. measures, averaging about 1.5 to 1, a result that is in line with other recent regional studies, but which differs from previous U.S. studies. Pooled data also strongly suggests that Okun’s coefficient in the U.S. is asymmetrical, negative output changes are associated with larger changes in employment than positive ones, though this result is sensitive to how one defines downturns. No strong evidence of a structural break was found. Additionally, this paper tests the resulting coefficients against a variety of labor supply and demand variables, to see which ones influence the existence and size of the relationship. These results support the generally accepted notion that high unionization rates, large manufacturing sectors, and high tax rates lead to a higher Okun’s coefficient. The size and composition of the labor force is also important. As more women and youth enter the work force, unemployment rates become less responsive to output growth. Political issues did not seem to have much effect, though some government policies did. Evidence is presented of interstate migration as an explanation of dynamics in Okun’s coefficient, though no statistically significant results were found. Finally, an extended form of Okun’s coefficient, one that accounted for variance in capital stock and capital and labor utilization rates, was tested for the ten most populous U.S. states. These tests gave a lower estimate for Okun’s coefficient – as most macro theories with diminishing marginal returns to labor, would predict. However, they did not seem to add much explanatory power to our original estimates, and in most cases gave a less robust result.