ECONOMIC PROGRESS AND UNEMPLOYMENT: is there any correlation?

Abstract

This paper examines how a common labour force statistic, such as the unemployment rate, can play a vital role in the economic progress of a developing country like Pakistan.

Empirical evidence abroad suggests that unemployment is a key variable when it comes to any discussion of economic improvement; this finding is supported through both primary and secondary sources. Annual unemployment rates and GDP (per capita) are in fact related to each other, and the extent of this relationship is further examined in this article through a basic regression model on data from the 1980s to 2010.

The findings of this study are supported by evidence published in online journals and research papers, by vast global organisations such as the International Labour Organisation (ILO) and other Pakistan-based research groups.

 

Keywords: Gross Domestic Product, unemployment, labor force statistics, Pakistan.

 

Introduction:

The future looks bleak for the citizens of Pakistan as the end of the Fiscal Year 13-14 looms closer. Amid political unrest, rising inflation and the accumulating indebtedness, Pakistan currently lies amongst the lower middle income developing countries of the world, with relatively low GDP growth (annual).

Amongst all the other current ‘hot’ topics of discussion is rise of unemployment rates that the country is facing this year. A recent report published by the ILO states that Pakistan is predicted to see a surge in unemployment rates this year (2014) followed by five years of near stagnant unemployment from 5.29 pc to 5.5 percent (Global Employment Trends Report, ILO 2014).

Another article in a local newspaper states: “…creating jobs should be difficult in 2014. The persistent uncertainty and political unrest implies that Pakistan’s economy may lag behind the progress-oriented countries in South Asia” (Express Tribune, 22/01/14)

It is a well-established fact that unemployment rates and annual GDP are two correlated variables. Empirical evidence from the US suggests that economic growth (measured via GDP as an indicator) and unemployment are negatively correlated, with the correlation figure quoted as -0.38 (Forbes, 2012). This paper attempts to examine this relationship for Pakistan, to see whether the current surge in unemployment can be traced to Pakistan’s GDP trends.

The article has been divided into two sections, for the ease of the reader. The first part deals with providing a background to the study, and an explanation of the variables through an intensive literature review. The second part attempts to form a basic model of unemployment rates and GDP per capita for Pakistan for the past 30 years, to see whether the relationship does in fact exist. These two sections are followed up by a short conclusion that sums up the importance of these findings, and how they are a vital indicator for the economy of the country.

 

 

Objective of the Paper:

To see whether a significant relationship does in fact exist between both unemployment rates and economic growth in a country, and what this means for future growth and sustainability (via empirical and secondary research).

 

Literature Review:

This first part of the paper basically deals  with providing background and secondary evidence for our area of study.

  1. In the article, Economic growth and the unemployment rate, Linda Levine discusses relationships between unemployment and the annual growth rate of a country. The author states that the relation remains partly undefined in the short run but in the long run, there exists a negative relation between the two, i.e. as growth rate decreases, unemployment increases. The author establishes how Okun’s law can be incorporated into the system, and how the findings of the law help us study the modern day economic standings of different countries. According to the findings, if growth in GDP exceeds the growth in labor productivity (GDP growth rate increases with increased productivity).  In the US, a minimum growth rate of 2.5% is required to decrease unemployment from its current standing. (Levine, 2013)

This article proves our hypothesis correct as the results show that GDP growth rate is inversely related to the unemployment in the country.

 

  1. Reviewing the Okun’s law:

Arthur Okun first talked about the long term relation between the annual growth rate and unemployment in 1960s. It basically studies that how much of the annual growth is lost due to the unemployment rate above the natural level of unemployment. Since there is a positive relation between output (growth dependent on output) and employment, there naturally exists a negative relation between output and unemployment. The law includes that to decrease unemployment the growth rate of the economy must exceed its set potential. According to the regression results of Okun, for every 1% decrease in unemployment, the GDP grows at a rate of 3%. (Okun, 1960)

The Okun’s law helps prove our hypothesis correct, as according to the results of the research of Arthur Okun, a negative relation between unemployment and the GDP growth rate.

 

  1. In the Highlights of the Pakistan Economic Survey 2012-13, it is stated that the economy of Pakistan grew on average at the rate of 2.9 percent per year during the last five years. The deterioration of the power sector has proved to be the main reason for this steady growth and has destroyed any possibility of achieving the potential growth rate of 6.5 percent per annum. Real GDP growth for 2012-13 has been estimated at 3.6 percent as compared to 4.4 percent in the previous year. The reason to these issues has been noted as the constantly increasing unemployment in the country. Unemployment has followed an upward trend as total unemployment rate increased to 6.0 percent in 2010-11. The number of unemployed people increased from 1.94 million to 2.1 million in Punjab, in Sindh from 0.57 million to 0.70 million in 2010-11. However, In KPK the situation is different the unemployed people decreased from 0.55 million to 0.53 million and in Baluchistan unemployed people increased from 0.06 million to 0.07 million in 2010-11. (Highlights of the Pakistan Economic Survey 2013, 2013)

This article further cements our hypothesis, as it not only approves our variables, but also our study area, i.e. Pakistan. It clearly states that though unemployment in KPK has decreased but the overall rate of unemployment has only increased throughout the country, and so has the annual growth rate, which fell short of the estimated growth rate.

 

  1. In the report, Poverty, Inequality, and Unemployment in Pakistan, the authors Ghulam Muhammad Arif and Shujaat Farooq have discussed that the overall unemployment rate increased from 6 percent in 2000/01 to 8.3 percent in 2003/04. However, it declined during the next four years until 2008 to 5.2 percent. During this period, the economy witnessed comparatively high growth and poverty reduced sharply. But the years 2009-2011 have seen an increase in unemployment. But this increase is not the case for the women in the urban areas of the country, and the males in the rural areas of the country. The major increase is seen in the youth, they have high unemployment rates. A comparison between Pakistan and the other South Asian countries has been drawn, which shows that no matter what the basic unemployment level is, the unemployment rate in youth is comparatively high in this region. (Ghulam Muhammad Arif, 2011)

This report supports our hypothesis.

 

  1. A report on the Social Sector of Pakistan discusses key elements of the economy, and establishes a relation between the unemployment and the growth rate.  It highlights how hindrances in social sector developments cause the unemployment to increase. But these hindrances at times result from decreased GDP growth, resulting in unemployment, or at times  these hindrances cause unemployment, leaving the economy crippled in its own way (more unemployment, less the output)

This report again partly accepts our hypothesis.

 

The literature available in this regard was limited for Pakistan, but sufficient to draw a secondary result. That is, up until now, our hypothesis remains accepted.

 

Data analysis:

The data for unemployment and GDP per capita have been taken from The World Bank

In 1982, Pakistan’s GDP per capita was Rs812.6 which steadily grew over an expanse of 26 years to Rs2720.5 in 2010. This is almost an increase of Rs2000. The GDP per capita has shown a steady increase but remained committed to an overall rising trend with no single year showing any fall.

The unemployment rate was at 3.75% in 1834, which increased in 2010 to being 9.3%. overall, all throughout the 26 years, Pakistan has witnessed an increasing unemployment rate constantly due to it increasing population and literacy but a very narrow base for economic growth to absorb the growing labor force.

Due to the data constraints, errors in measurement, a large amount of population living outside the umbrella of labor force survey and population census, coupled with migration of Afghans, it is expected that the unemployment rate may be much higher than that shown by the data.

 

 

Results:

Regressions equation:

log( unemployment) = c + log( gdp per capita) + u

1

 

The regressions analysis above shows that there is a significant relation between  GDP per capita and Unemployment in Pakistan. GDP per capita as the explanatory variable explains unemployment upto 87% as shown by the R^2 value. Hence the model is a good fit.

1 percent change in GDP per capita reduces unemployment by 0.93 percent, as shown by the analysis, the data analysis being free of heterogeneity and autocorrelation.

This explains that the findings of our result support the theory that economic growth which causes rise in per capita income reduces unemployment, therefore GDP per capita was used as the major factor explaining reduction in the unemployment and the result shows that it it indeed does so upto 87%.

The regression through simple OLS shows a significant relation between reduction in unemployment through a rise in per Capita GDP from a spread of 26 years in Pakistan.

The elasticity of unemployment to GDP per capita is 0.93.

 

 

Conclusion:

The results of this paper show that the prevalent unemployment rates, and the gross domestic product per capita do share a common time trend, and an inversely significant relationship.

Pakistan’s economic situation affects the unemployment pattern of the country, as the past thirty years’ worth of data show.  As the GDP grows in the country, the unemployment level generally falls; while the converse is true. While the relationship is a cycle in itself (i.e. increase in GDP causes a decline in unemployment rates, which further increases economic growth through worker productivity), it works in a single direction too, as reflected by our model.

This finding highlights a very important point for policy makers while dealing with labour market issues and poor productivity. An increase in economic activity in the country can help create jobs, thus lessening the burden of the unemployed on the country’s resources. Similarly, training unskilled workers can convert unemployed labourers into productive citizens, thus bringing the country closer to its goal of inducing economic growth, and hence progress.

 

 

References:

 

Express Tribune (January 22, 2014) Unemployment in Pakistan set to increase in 2014: ILO report

http://tribune.com.pk/story/662013/ilo-report-pakistans-unemployment-rate-to-remain-same-till-2018/

 

The Key to Economic Growth: Reduce The Unemployment Rate. (Forbes, 27/8/12) Accessed Online

http://www.forbes.com/sites/mikepatton/2012/08/27/the-key-to-economic-growth-reduce-the-unemployment-rate/

 

Highlights of the Pakistan Economic Survey 2013.

Ghulam Muhammad Arif, S. F. (2011). Poverty, Inequality, and Unemployment in Pakistan. PIDE.

Levine, L. (2013). Economic growth and the unemployment rate. Congressional Research Service, 3-6.

Okun, A. (1960). Okun’s Law.

 

 

 

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