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Is Okun's Law Broken? SF Fed Discusses Why Record Worker Productivity Is Painting An Overly Optimistic Jobs Picture

Tyler Durden's picture


One of the big puzzles over the past several months has been the apparent plateau in the unemployment rate, even despite a double dip in initial claims and an overall sentiment that the economy is ready to take a second, post-stimulus, leg down. Aside from the traditional allegations of data fudging by the BLS, one concept often presented has been the unprecedented surge in labor productivity, which despite overall declines in hours per worker and a deterioration in the labor force, has allowed GDP to not only regain its losses from the recent lows, but to stage a dramatic improvement. Today, in a must read paper, the San Francisco Fed tackles precisely this topic, and comes to the unpleasant conclusion that unemployment rate forecasts may well be too rosy for 2010 and beyond, especially if companies continue to sacrifice workers at the expense of ever increasing "worker productivity" which in itself is about as "credible" as any other data series presented by the government over the past year.

The core of the article revolves around a recently observed record variation from the expected Okun Law distribution of the Output Gap and Unemployment, which as can be seen in the chart below, has never been as dramatic as in Q4, 2009.

Here is a brief observation on what the chart above details:

The figure plots the relationship between deviations from trend of real GDP and the unemployment rate from the first quarter of 1949 through the fourth quarter of 2009. Trends are taken from the Congressional Budget Office’s (2010) most recent estimates. The dotted line plots a statistical relationship between the output and unemployment gap from the first quarter of 1949 through the first quarter of 2007. As the plot shows, the empirical association that Okun noted generally describes the  data well. This is true across different points in the business cycle and across a long span of time.

Indeed, early in the 2007 recession there was little evidence of divergence from Okun’s law. In the second quarter of 2009, however, things went off track and a wedge began to emerge between changes in output and changes in unemployment. As shown by the red squares appearing above the line in Figure 1, the familiar two-for-one pattern broke down and unemployment went up by substantially more than expected. By the fourth quarter of 2009, the deviations in output to unemployment were the largest observed over the span of the data. The divergence of the current data from the typical pattern wreaks havoc with forecasters, but also leaves a puzzle: Why did unemployment rise so rapidly in 2009?

The FRBSF then goes on to detail the key variables that go into determining the output gap and overall unemployment: the labor market participation rate, the hours worked per worker, and, most notably the GDP per nonfarm hour:

The first point to consider is whether changes in worker behavior have boosted the unemployment rate and disrupted the Okun’s law relationship. As the first panel of Figure 2 suggests, labor force participation, or the fraction of the working-age population reporting that it is working or looking for work, has bounced around during this downturn. Typically, labor force participation will fall in a downturn as potential workers realize their prospects are weak and withdraw from the labor force to pursue other goals or because they are discouraged. In the first year of the recession, this normal pattern failed as individuals remained in the labor force despite the weakening economy (Daly, Hobijn, and Kwok 2009). However, by 2009, this pattern had reversed and labor force participation dropped precipitously. Currently, the trend in the labor force participation rate is helping reduce, rather than boost, measured unemployment.

Another factor that might be contributing to the breakdown in Okun’s law is hours worked per employee. In recessions, the number of hours worked generally falls as firms cut back on overtime or regular hours in response to declines in demand. By reducing worker hours instead of reducing the workforce, firms lay off fewer workers. If this recession were different and firms laid off more workers and then worked the remaining ones longer, then we would expect some deviation in the normal GDP/unemployment relationship. However, the second panel of Figure 2 does not support this hypothesis. The hours worked per employee is roughly in line with previous periods and, if anything, is working to reduce, rather than increase, the wedge in Okun’s law.

The final panel of Figure 2 points to the factor that turns out to be the main driver of the recent departure from Okun’s law—average labor productivity, measured as GDP per nonfarm hour worked. The deviation in average labor productivity relative to the GDP gap is far outside the range plotted over time and is consistent with the rapid productivity growth recorded in 2009. The surge in labor productivity allowed employers to keep output steady while shedding workers and reducing hours of work in the economy. As such, it allowed unemployment to rise much more than expected given the change in GDP, breaking the normal pattern between the two measures observed over the past 60 years.

A longitudinal time-course analysis presents these finding in a more digestible way: the only reason why GDP has not collapsed, and why the output gap is not double where it is presented to be, is exclusively due to workers who are currently employed playing far less Solitaire and just happy to have their jobs, even though average wages have continued to be at cycle lows.

The authors' conclusion is a troubling one, not just because it comes from the Federal Reserve itself, which is always conflicted and has a propensity to demonstrate data in the rosiest picture possible, but because they are in fact, very much correct in their interpretation.

The data presented here consistently point to unusually strong productivity growth as the main driver of the departure from Okun’s law in 2009. A key question that remains unanswered by this analysis is whether this pattern will continue in 2010. Most forecasters assume that the economy will return to its historical path this year, following Okun’s two-to-one ratio of changes in GDP and changes in unemployment. Under this scenario, unemployment would begin to edge down this year as the economy recovers and gains momentum. But there are clearly risks to this view. Some of the surge in productivity growth in 2009 was likely due to such cyclical factors as layoffs of least productive workers, greater intensity of work effort, and shifts away from producing intangible capital, which is not measured in output statistics. Anecdotal evidence suggests that efforts to contain costs and remain nimble in the face of uncertainty have become a fixture in business strategy. If productivity keeps on growing at an above-average pace, then unemployment forecasts based on Okun’s law could continue to be overly optimistic.

While it would have been easier to buy the premise that Americans are suddenly far more productive because our civilization suddenly discovered the Internet, this is patently not true. The last secular boost to productivity came ten years ago with the advent of information commoditization courtesy of the interwebs. Since then the only major discovery has been the iPhone and Twitter, which one could argue detract from productivity, not add to it. Indeed, it is very hard to swallow that our economy has not collapsed merely because those who are employed have been cranking out widgets at a record pace.

Michael Pento does an astute, if somewhat perfectly cynical, analysis of this quandary.

I went through the last 20 years of productivity data and couldn't
find anything close to those three consecutive quarterly booms in
output per hour of work. It sort of like saying at the start of Q2 2009
we invented the internet and the wheel on the same day.

What makes the claim of surging productivity even more amazing is
that the U.S. economy is comprised of nearly 90% services. That means
waitresses must be kicking people out of restaurants before they are
finished eating or people have learned to eat much faster. Then again
maybe doctors have learned to truncate their exams of patients or
perhaps they have somehow found away to eliminated the second waiting
room you have to sit it once you get past the reception area.

I guess productivity gains can come by magic just through the
process of firing workers. Somehow we were are able to increase the
output of goods and services as a nation even though 8.4 million people
have lost their jobs and hours worked are down. What a relief it must
be for businesses to shed themselves of all that dead wood. If we are
to believe these productivity numbers we also must believe those
formerly employed individuals were doing nothing at all but standing
around with their thumbs up their bum.
Call me skeptical.

Skeptical indeed. And since there is a direct causal chain in the variables that ultimately lead to GDP, productivity is the one intangible where the conflicting data of rising GDP and declining workforce collide. The question is whether this is a cause or effect: is the Census bureau spinning (and spewing) data that has no bearing in the real world (i.e., GDP), with the weakest link being this unprecedented worker productivity? We leave it up to readers to decide whether they believe the productivity boost thesis is credible, although with even the San Fred Fed questioning it outright, we expect to see some major declines in GDP once productivity recedes to historic levels, if it is not accompanied by an increase in the work force. And based on contemporaneous data, even with massive BLS fudging, this is not going to happen any time soon, once again leaving us with the sad conclusion that all rumors of V- or U-shaped recovery are greatly exaggerated.

Full San Fran Fed paper.


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Mon, 03/08/2010 - 16:41 | Link to Comment Bam_Man
Bam_Man's picture

The bottom line is, if you believe the GDP numbers, then you the "fabulous" increase in worker productivity might seem plausible.

If you believe that the Guvvamint is massively overstating GDP due to flawed methodology and/or willful deception, then the productivity numbers are just another fraud/mirage.

Mon, 03/08/2010 - 16:46 | Link to Comment Cognitive Dissonance
Cognitive Dissonance's picture

"Michael Pento does an astute, if somewhat perfectly cynical, analysis of this quandary."

One of the few CNBC guests who will actually stand up to the bullying and question the cover story du jour.

Mon, 03/08/2010 - 16:45 | Link to Comment Fritz
Fritz's picture


What color is the Sky in BLS's world?

Regardless, it will be just another reason to ramp the S&P to 2000


Mon, 03/08/2010 - 16:53 | Link to Comment Stranger
Stranger's picture

High worker productivity is correlated with high-unemployment countries such as France for a very simple and obvious reason: labor regulations make employing anyone but a high-productivity worker unprofitable.

Mon, 03/08/2010 - 16:55 | Link to Comment Anonymous
Mon, 03/08/2010 - 16:56 | Link to Comment Anonymous
Mon, 03/08/2010 - 17:05 | Link to Comment CONners
CONners's picture

Fear and loathing of losing a job makes the heart grow more productive.

Mon, 03/08/2010 - 17:07 | Link to Comment HumbleServant
HumbleServant's picture

I own a small wholesale manufacturing company in the Southeast US and I can attest to the mentality of myself and many of my peers.

The first wave of layoffs (fortunately our company has only had one wave so far) were the semi-productive employees so that increased productivity with the remaining employees.  Most R&D was cut and that increased productivity.  The overall mentality of simply surviving with the resources we have has increased productivity.

Even though we are in the small percentage of manufacturing companies still left in this country, I'm sure that most service companies had some room to lean out their operations also.

Going forward, a lack of R&D and a total lack of confidence in the government (i.e. no capital investing) will start showing up in a year or two.

We're all on pins and needles out here just waiting for the next domino to fall.  I can assure you that the next leg down will be much quicker and deeper.  No plant owner is going to keep employees on the payroll "hoping" things are going to "get better soon" this next time.

Mon, 03/08/2010 - 18:31 | Link to Comment SteveNYC
SteveNYC's picture

What an excellent, true, and scary analysis. I work with companies like yours day in day out, my ears and eyes are very close to the "real" economy.

I commend you for sticking it out and doing it in a way that built this country. Real risk, real reward, real work. All the best.

Mon, 03/08/2010 - 18:59 | Link to Comment HumbleServant
HumbleServant's picture

Thanks SteveNYC.  I'm going to hang in there as long as I can for my employees and their families but there is a very disturbing situation developing here in the US.

You have a very small number of people in this country that have the organizational skills, people skills, capital, technical knowledge, etc. to run small and medium sized companies.  These are the guys that can make the decision to pull the plug on the whole plant at any time.

We have had to cut our prices and wages back to 2006 levels to keep playing the game.  At the same time, insurance, taxes and most fixed overhead has gone up.  You have a lot of owners working 60+ hour weeks trying to keep things going while bringing home less than many of their employees.

Most of this group of people are in a pretty decent financial situation personally and are probably not worried about their own futures but many of their employees live paycheck to paycheck.  We're on the edge of profitability right now and another big setback in the economy is probably going to push a lot of owners into "decision time".

If you owned a $10 million dollar a year company with all of the liability, stress, etc. in a business environment like this and were bringing home $50K per year, you would be thinking about making major changes.  If even a small percentage of the people in this group decide that this environment isn't worth playing in any more, the next leg down isn't going to be pretty. 

Sat, 03/13/2010 - 12:45 | Link to Comment SteveNYC
SteveNYC's picture

Bless you man, I hope it works out for you, your family, and your staff.

Mon, 03/08/2010 - 17:08 | Link to Comment Sancho Ponzi
Sancho Ponzi's picture

C'mon, guys, logic is sooooo 2nd millenium.

Mon, 03/08/2010 - 17:14 | Link to Comment SayTabserb
SayTabserb's picture

If you can't trust either the numerator or the denominator, what's the point of long division? The GDP figure is fake, the unemployment rate is fake, and this is an analysis about nothing. The tax receipts listed by the Treasury every month probably tell a clearer story. Those keep going down. I realize the govt. is determined to send more and more money back to the taxpayers in an effort to buy their votes (the "tax cut" tranche of the stimulus bill), but this is the clearest indicator that the economy is just wallowing and going nowhere but down. There is less money being made, period. What good does a fabricated GDP figure do in the face of that?

Mon, 03/08/2010 - 23:17 | Link to Comment Crab Cake
Crab Cake's picture

If you can't trust either the numerator or the denominator....

Would that make it an irrational or imaginary number?

Tue, 03/09/2010 - 00:05 | Link to Comment Anonymous
Mon, 03/08/2010 - 17:16 | Link to Comment SimpleSimon
SimpleSimon's picture

Not to worry, we have the public sector ready and willing to correct this pesky productivity surge.

Mon, 03/08/2010 - 17:28 | Link to Comment Anonymous
Mon, 03/08/2010 - 17:36 | Link to Comment Anonymous
Mon, 03/08/2010 - 19:34 | Link to Comment johnny9iron
johnny9iron's picture

You are correct. It stares you in the face after you think about it and it explains why the data doesn't read like it is supposed to.

Mon, 03/08/2010 - 17:39 | Link to Comment Anonymous
Mon, 03/08/2010 - 17:45 | Link to Comment Anonymous
Mon, 03/08/2010 - 17:47 | Link to Comment Anonymous
Mon, 03/08/2010 - 17:50 | Link to Comment Anonymous
Mon, 03/08/2010 - 17:54 | Link to Comment tmosley
tmosley's picture

There is a nasty problem with worker productivity figures in that when a US job is outsourced, the work done by the foreign workers is counted as US productivity.  I read this in one of Peter Schiff's commentaries, but I don't know if it is true or not.  Can anyone comment on that?

Mon, 03/08/2010 - 18:05 | Link to Comment Margin Call
Margin Call's picture

This op-ed in the NY Times recently brought up this "minor" detail:

Welcome to the United States, the world's first virtual economy?

Mon, 03/08/2010 - 19:04 | Link to Comment tkoski6600
tkoski6600's picture

Thanks for this link!

Mon, 03/08/2010 - 17:56 | Link to Comment carbonmutant
carbonmutant's picture

 The next administration gets to look at the books...

Mon, 03/08/2010 - 17:56 | Link to Comment Anonymous
Mon, 03/08/2010 - 18:00 | Link to Comment Bear
Bear's picture

The real issue is ... when a company finds out that they can get by with fewer people to do the same work they will never hire back workers or will do it so slowly that unemployment gains will be excruciatingly slow even if the economy magically recovers. But then how will the economy recover if unemployment doesn't abate?

Mon, 03/08/2010 - 18:02 | Link to Comment Anonymous
Mon, 03/08/2010 - 18:02 | Link to Comment mynhair
mynhair's picture

I think it is as simple as some of the jokers that have been fired had negative productivity.  Think of those morons you've seen in a business, like the computer store where the lametard won't sell you a system with XP unless you come up with a valid certificate.

Mon, 03/08/2010 - 18:26 | Link to Comment SteveNYC
SteveNYC's picture

Imagine what the "productivity" of a slave worker is? No/little pay, no benefits, small amounts of sustenance, long hours, no vacations, and they'll work as hard as you can whip them.

Now, if only we can apply that to the modern-day US worker (as is more and more becoming the case) we will have AMAZING productivity figures that will give Greenspan and Bernanke a woody.

We can be the most productive workers in the world!!

Mon, 03/08/2010 - 21:29 | Link to Comment wake the roach
wake the roach's picture

Imagine what the "productivity" of a slave worker is? No/little pay, no benefits, small amounts of sustenance, long hours, no vacations, and they'll work as hard as you can whip them.


Well thats where all monetary systems eventually lead, but of course it never makes it that far. Where you are mistaken though is that human labor is required at all...

Technological unemployment my friend, it is THE most fundamental cause of capitalisms inevitable demise...

Technology has and will continue to replace all human labor at exponential rates. This is fact, not some far off distant dream. Problem is that technology has already made monetary systems obsolete at allocating finite resources, we are witnesses to this everyday... 

We have the technology and the knowledge to provide for the needs of every human being on this planet without money and with a lifestyle and a future of unlimited potential...

But of course this will not happen, not for lack of ability but through outright fear...

And so the next monetaty system to prostitute humanity will be the carbon standard of capitalism. This will once again provide employment (aka slavery) by means of making carbon energy incrementally unaffordable to those that inhabit the lower levels of the pyramid...

Yeah, sounds crazy right but tomorrows elites will grow rich from creating, amassing and distributing carbon offset instruments and credits, developing sustainable energy technology and by any means of gaining energy/resource efficency over competitors... Not gold bullion...


Mon, 03/08/2010 - 19:06 | Link to Comment Anonymous
Mon, 03/08/2010 - 19:07 | Link to Comment Anonymous
Mon, 03/08/2010 - 19:09 | Link to Comment Anonymous
Mon, 03/08/2010 - 19:39 | Link to Comment Augustus
Augustus's picture

This is how the productivity of the US worker increases:

Company originally had 20 Execs and design engineers. They also had 70 production employees. Finally they had 10 employees in delivery. Shift to China production.


Now they have 18 execs and engineers as they can lay off 2 HR people and an accountant but hire a PR person to tout improved quality. Layoff 68 production employees with two left for inspection and rework. Keep the 10 truck drivers but pay them less as there is excess labor available.

Cost of goods sold decreases by 40%. Total Revenues decline 10% from competitive price reductions and leads to a lower inflation number.  Profits go through the roof. Revenues and profits per remaining employee increase a great deal. It appears that there has been an increase in efficiency of those employees. Even energy use per unit sold will show a politically correct decline as the energy is now consumed in China.


The laid off employees can go the the local get together place and play parchiese while they draw the never ending benefit checks for doing nothing. It is more dignified to be unemployed and eat someone else's food than to get a new job and compete.  It is the Detroit model of the big bust out, but applied to the entire economy.

Mon, 03/08/2010 - 20:47 | Link to Comment Anonymous
Mon, 03/08/2010 - 22:00 | Link to Comment Anonymous
Mon, 03/08/2010 - 22:04 | Link to Comment moneymutt
moneymutt's picture

Is this worker productivity a US thing or global thing? And there is a lot that goes into "productivity". When you think the economy is expanign you are more likely to invest in product development, marketing, research, new technology but when you think things will be flat or backtrack, you tuck in a lay off the people who did the above things for you and just retain the basics, and squeeze the remaining scared crapless employees.

Also, it started long before this recession but was masked by housing appreciation and investment i US but jobs are leaving US when they can so only jobs left in US are ones US workers are best/most productive at. Local fortune 500 company here laid off their Director level guy that managed their call center, the call center is shrinking and being outsourced to India et al in pieces, so they just lopped off the expensive guy with MBA who had been with company and loved for 25 years. When I said to someone that knew him, at least his knowledge in managing a call center is transferable, he said, yeah if the rest of US companies weren't all downsizing their call centers. And this company's profits were done 1 percent last year, but laid off more than 1 percent of their workforce in Jan, let alone no hiring to compensate for attrition. I have to think some of this "productivity" is due to global outsourcing, depending on how they calc it.

and I agree, technology is taking its disruptive bite also

Mon, 03/08/2010 - 22:44 | Link to Comment Anonymous
Tue, 03/09/2010 - 09:43 | Link to Comment Brick
Brick's picture

Big business is going through a step change to reduce cost and reduce leverage. They are looking back at 2009 and seing weaknesses in the business model and positioning themselves either for the next upturn or downturn.
The easiest way to reduce costs is to automate a manual procedure, followed by re-organising processes so they take less time. Essentially a robot improves productivity without making the remaining workers work harder.
This was always going to happen over time, but the downturn just accelerated this process. Government are of course behind the curve yet again and needs to start to come to terms with the fact that the world does not need as many workers as it did.

Fri, 03/12/2010 - 18:02 | Link to Comment Anonymous
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