Okun vs. Verdoorn: distinguishing between cyclical and structural effects of output on productivity

Abstract

According to Kaldor and Verdoorn, the evolution of output is expected to structurally enhance labour productivity by generating economies of scale. At the same time, Okun’s law suggests a pro-cyclical association between output and productivity. These two aspects of the relationship often pose challenges in empirical studies when distinguishing between short-run (à la Okun) and long-run (à la Verdoorn) effects. In light of these complexities, our paper offers three contributions. First, we discuss the extant approaches to the estimation of long-run Verdoorn effects. Second, we investigate the presence of a short-run, Okun-like effect. Third, we propose a methodological advancement to separate the cyclical from the structural relationship between output and productivity. We employ panel cointegration-based techniques on data from a large set of OECD countries over the period 1970–2019. Our findings reveal a short-run coefficient of about 0.3 between growth rates and a long-run elasticity of about 0.5 between levels.