Is Okun's Law dead?

The question may seem an arcane one outside the confines of an economics class, but the answer could have a serious impact on the nation's chances of returing to prosperity.

Essentially, what Okun's Law does is to provide a basis for gauging how rapidly policymakers can spur the economy without inviting new inflation. If the maxim no longer is valid, planners will have lost a major tool.

The principle was developed in the early 1960s by Arthur Okun, a former Johnson administration presidential economic adviser, as a way of expressing the relationship between economic growth and reductions in unemployment.

Okun calculated that it took an extra 3 percentage points of economic growth to produce a one-percentage-point decline in the nation's unemployment rate. For the bulk of the 1960s and early 1970s, the maxim worked.

But now some economists believe Okun's Law may be going the way of the Phillips Curve - the Keynesian gauge for measuring the once "classic" tradeoff between unemployment and inflation.

The Phillips Curve had been a maxim for years. But it was abandoned in the early 1970s, when changes in the makeup of the labor force - mainly the growing proportion of women and teenagers - altered the old relationships.

Now, almost eveyone agrees that the Phillips Curve is dead.

What has punched holes in Okun's Law in recent months is the change in another somewhat arcane-sounding measure - the size of the productivity gains that the nation can expect to achieve over the long run.

When productivity began slowing in the early 1970s from its previous longterm "trend path" of 3.2 percent, economists thought the falloff was temporary and would resume again when the economy rebounded.

But that never happened. Instead, the nation's productivity - that is, the average hourly output of an American worker - his continued to slow drastically. And most analysts are convinced it is unlikely to bounce back anytime soon.

The development is important because the more lackluster the nation's productivity growth, the less the economy can tolerate large wage increases without exacerbating inflation. And that limits overall economic growth.

The reason all this affects Okun's Law is that the 3-to-1 ratio that Okun cites for the effect of the economy's growth rate on unemployment is based on the assumption that productivity will continue at its historic growth rate. With productivity in its present slump, the relationships all are thrown askew.

The problem implied in the death of the Phillips Curve was that policymakers lost their basic remedy for combating inflation. With the old "tradeoff" weakened, creating a mild recession no longer slowed price increases.

The dilemma for policymakers is that if Okun's Law no longer is valid, there really is no reliable way to figure out what specific economic growth rate the government should aim for.

The Carter administration essentially is predicting a 3.2 to 3.8 percent economic growth rate for 1979, but no one is really sure whether it is the right target.

Would a 3.8 percent increase in the "real" gross national product intensify inflation in the current economic situation? Or would it be fast enough to to keep unemployment declining? Policymakers don't know.

When productivity is low, it means virtually all the gain in the economy's output has to come from new hiring. But today, with the economy close to full employment, much more new hiring could send wages - and inflation - soaring.

As a result, if policymakers hold to a moderate growth rate, they inadvertently could find themselves in an inflationary boom. Without Okun's Law as a guide, shaping economic policy could be more precarious than ever.

Okun himself - and not merely for self-serving reasons - insists it still is too early to declare his maxim dead. The basic relationships proscribed are still there, he argues. It may be all that's needed is to juggle the numbers.

But if Okun is wrong, and his law has indeed gone the way of the Phillips Curve, then policymakers will be even more uncertain about what is the correct prescription for the American economy.

And in today's difficult economic situation, that can't be very comforting at all.