NEW YORK (MainStreet) — The gross domestic product is arguably the single most important economic indicator, but for many Americans, its quarterly changes likely seem abstract at best.
The primary purpose of the GDP is to tell us whether the country’s economic output is increasing or decreasing – and by how much – compared to the previous quarter or the previous year. That’s why economists will use the GDP as a marker to determine if we are in a recession or not. But what many may not realize is that the GDP can also provide some insight into the overall strength or weakness of the labor market.
While any increase in the GDP is good because it indicates that the economy is expanding, economists generally say that the GDP needs to be growing by close to 2.5% each quarter just to tread water and stop the unemployment rate from ticking up.
“You need to create somewhere between 100,000 and 150,000 new jobs a month because that’s how much the labor force increases on average,” says Paul Ashworth, senior U.S. economist at Capital Economics. In general, an economy that expands at 2.5% will create enough jobs to do just that, but not much more.
Beyond that, economists have traditionally relied on a fairly straightforward formula to determine the relationship between GDP and the unemployment rate, known as Okun’s law. In short, this formula states that the economy needs to grow by 2% just to maintain its current gap between actual output and potential output. For each percentage point that the GDP increases above that point, the output gap narrows and the unemployment rate drops by half a percentage point.
So by this standard, if the economy grows by 3%, the unemployment rate should drop by half a percent, and if the economy grows by 4%, unemployment should drop by a full percentage point. This standard holds up decently well if you consider that the GDP grew by 2.8% in the fourth quarter of 2011 and the unemployment rate dropped by half a percentage point in that same time period.
However, Ashworth notes that several factors have made the GDP a less accurate predictor for job growth in recent years. For starters, he says that many discouraged workers have left the labor market after failing to find jobs, which has had the effect of exaggerating the drop in the unemployment rate (since they are technically no longer looking for work), even though the percentage of the population without jobs remains high.
Moreover, much of the increase in the country’s output may be due to an increase in the average productivity of workers rather than the number of people who are employed. This, Ashworth says, is a result of companies trying to produce more with less and asking existing workers to take on more tasks.
Even with these new variables, Ashworth says that if you hear the GDP is greater than 2.5%, it means there are more job opportunities, and if you hear the GDP is less than 2%, the unemployment rate will likely tick up again.
Seth Fiegerman is a staff reporter for MainStreet. You can reach him by e-mail at firstname.lastname@example.org, or follow him on Twitter @sfiegerman.