“TESTING OF OKUN’S LAW”: THE ROLE OF COMPOSITION OF GDP

Abstract

This study examines Okun's Law—the inverse relationship between unemployment and output growth—across 157 countries over the period 1991-2014. Using both the difference model and gap model approaches, we estimate an average Okun's coefficient of -1.17 and -1.6 respectively. While the law holds significantly for 139 countries (88%), we identify considerable cross-country variation in the magnitude of the coefficient. Importantly, we extend the literature by analyzing the sensitivity of Okun's coefficient to GDP sectoral composition. Our findings reveal that economies with larger shares of services and manufacturing sectors exhibit higher Okun's coefficients, suggesting these economies face greater output costs from  unemployment increases. The coefficient increases by 2.76 percentage points with each percentage point increase in services sector share, and by 5.65 percentage points with manufacturing sector expansion. Panel data analysis using fixed effects confirms that Okun's Law is more applicable to developed economies with dominant tertiary sectors than to traditional economies relying on primary sectors. These results have significant implications for developing countries undergoing structural transformation.