factors affecting the unemployment rate in european countries in 2000 2019 period

That gives an advantage to job hunters and provides more opportunity to the citizens on the margins of the labor force, including those less educated, disabled people and ex-offenders… O

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TABLE OF CONTENT

ABSTRACT 3

INTRODUCTION 4

MAIN CONTENTS 5

I Literature review 5

1 Empirical researches on the factors affecting unemployment 5

2 Factors affecting unemployment rate 9

II Theoretical framework 10

1 Theory of unemployment rate 10

2 Okun's law 12

3 The Phillips curve 13

4 The Malthusian theory 14

III Empirical model 15

1 Specification of model 15

2 Definition of variables 15

3 Expected signs of variables and explanation 16

IV Data analysis 17

1 Data source 17

2 Data descriptive 17

3 Correlation analysis 18

V Estimation results and diagnostic tests 19

1 Estimation results 19

2 Diagnostic tests 21

CONCLUSION REMARKS 25

REFERENCES 26

or before Dec 31, 2020

Therefore, we have chosen the topic “Factors affecting the unemployment rate in European countries in 2000 - 2019 period” with a view to apply our knowledge about econometrics to know more about the unemployment rate

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INTRODUCTION

The unemployment rate is one of the primary economic indicators used to measure the health of an economy It tends to fluctuate with the business cycle, increasing during recessions and decreasing during expansions It is among the indicators most commonly watched by policy makers, investors, and the general public

Countries with lower unemployment rates tend to find it easier to stabilize their economy, because a low unemployment rate means there are fewer available workers for each job opening That gives an advantage to job hunters and provides more opportunity to the citizens on the margins of the labor force, including those less educated, disabled people and ex-offenders… On the other hand, high unemployment rate will lead to a fall in the Gross Domestic Product (GDP), which causes lower efficiency of production Additionally, low unemployment forces employers to raise pay more in order to attract and retain workers Wage growth is expected which will put more money in citizens’ pockets and result in increased spending, boosting the economy

The objective of the study is to measure and explain the impact of factors on unemployment in each country around the world, and consider the reasons those factors affect the unemployment rate From the results of this analysis, the study aims to make

a number of proposals and opinions on the issue of unemployment in the world and Vietnam in particular Understanding the level of influence of each factor on unemployment is the premise for planning appropriate economic policies to solve the problem

In the report, we will use the econometric model to find out the relationship between those factors and the unemployment rate by using collected data from the World Bank

In more detail, we will take a look among all countries around the world, in order to see

if those countries have similarities among this topic

MAIN CONTENTS

I Literature review

1 Empirical researches on the factors affecting unemployment

Unemployment refers to people of working age who desire to have a job but are unable

to find one Unemployment rate is one of the macro variables which attract considerable attention not only from governors but from scholars, students and the labor force as well The impacts of other factors such as population growth, minimum wage, foreign direct investment, inflation…upon the fluctuation of the unemployment rate have been long studied by generations of economists Regardless of the differences in conclusions, each finding is based on one particular empirical model including many of aforementioned independent variables in relation to the unemployment rate In the following part, we will discuss more about the recent empirical researches on the factors affecting unemployment

● Population growth rate

A minor change in population of a country or community can dramatically modify the unemployment rate As claimed by El-Agrody (2010), the effect that population growth rate imposes on the unemployment rate is the mismatch between the increasing number

of workers searching for a job and the limited employment opportunities This not only furthered the complicated situation but also led to a higher rate of unemployment Additionally, according to Paul O.Flaim (1970), during the 60’s and 70’s, the unemployment rate had an upward trend due to the growing rate of population Hence, the population of the community became denser and eventually observed a downfall in the decade of 1980’s On the contrary, the group of 5 Chinese postgraduates including Chen Li Xuen, Chew Yun Bee, Rick Lim Li Hsien, TanWanYen, Twe Kah Yee (2017) stated that the population growth rate affects the rate of unemployment negatively In short, it is obvious that the fluctuation in population growth rate has a major influence

on the rate of unemployment depending on the labor force distribution in the researched economy

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● GDP growth rate

Gross Domestic Products - GDP has long provided a snapshot of an economy since it

is used to estimate the size as well as the growth rate Hence, in terms of unemployment rate, GDP is regarded as an essential statistic to evaluate There are numerous studies researching the influence of GDP growth on the unemployment rate According to Dahmani, Mohamed Driouche and Rekrak, Mounia (2015), there is an inverse relationship between the two variables Specifically, one percent increase in economic growth is associated with a reduction in the unemployment level by 0.265 percent in the long run The same result was pointed out by Aqil, Qureshi, Ahmed, và Qadeer (2014), Olawunmi Omitogun, Adedayo Emmanuel Longe (2017) and Yılmaz Bayar (2014) These studies estimate the Okun’s coefficient as well as check the validity of Okun’s law in different countries in the world In addition, Sanchez, J M., & Liborio (2012) examined the logiditual relationship between GDP growth and unemployment for the MENA countries They came to the conclusion that GDP growth is needed to create new jobs and initially reduce the unemployment rate

● Foreign Direct Investment

Foreign Direct Investment is regarded as an action to conduct long-term investment in other countries In recent years, the impact of FDI on labor market conditions has been intensively researched These researches were both theoretical and empirical in nature However, there are several disagreements about the interrelationships between FDI inflow and employment

On the one hand, some literature emphasizes that FDI possesses significantly positive interrelation with employment, international trade and employment Chief among these researchers is Axarloglou and Pournarakis (2007) These researchers investigated the impacts of FDI inflows on employment in the manufacturing sector from a regional perspective in the United States in the years 1974-1994 Based on their findings, FDI inflows in printing and publishing and transportation equipment are indicated to stimulate the labor markets of most US states in the sample Similar results can be found

in Bailey and Driffield’s econometric investigation (2007) into the effect of inward FDI

upon the demand for skilled and unskilled workers in the UK based on industry level data panels Moreover, in the case of developing countries, the positive influence of FDI

on employment growth was found in China during the period of 1998 - 2004 by Karlsson et al (2009) He analyzes the FDI inflow and employment growth in China based on firm level evidence and comes to the conclusion that as one of the world's most important recipients of FDI, the Chinese labor market has significantly benefited from foreign capital inflow The results of the research not only showed that FDI has positive impacts by creating new jobs within the foreign firms but also has an indirect effect on employment in domestic firms Correspondingly, the Pei and Esch (2004) also attempt to examine the overall effect of FDI on developing nations' economic conditions They begin their study at a micro level, focusing on the banking and corporate sectors and then move on to macro level, where they have an insight into trade, employment and the balance of payment Their investigations declared that both theoretical and empirical data suggests that FDI has a positive influence on host developing nations' economic situation However, all the researchers mentioned above share the same concern that it is impossible to precisely evaluate the effect of FDI on employment

On the other hand, some literature argues that FDI has no considerable or even negative contribution to either any employment aspects or economic growth of the host country Especially in 2009, Aktar and Ozturk who applied VAR methodology to

investigate various interrelationships among FDI, exports, unemployment and GDP in the years of 2000-2007 in Turkey Their research revealed that FDI did not have any contribution in reducing unemployment rate in Turkey during the surveyed period One researcher who shares the same point of view with Aktar and Ozturk was Chen T.J First, he and his partner - Ku Y.H (2000) studied the impact of FDI on firms’ growth in Taiwan They discovered that while FDI benefits local industries and trade, it has little

or no influence on employment After that, in his article about Taiwan’s manufacturers (2006), by analyzing Okun’s law, he claimed that there is a negative correlation between unemployment and economic growth or FDI in imperfect competition

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● Inflation

The nature of inflation - unemployment relationship has ramifications for the appropriate implementation of monetary policy, which aims to promote economic growth by employment creation and price stability However, despite advances in both theoretical and empirical evidence, the question of whether the inflation and unemployment interaction in an economy conforms to the traditional Phillips curve relationship remains disputed Theoretical and empirical literature on the Phillips curve stretches back to the 1950s when Phillips (1958) laid the groundwork for his infamous finding He examined wage inflation and unemployment statistics in England from 1861

to 1957, then, established an adverse interrelation between these two variables Since then, although the literature has advanced with variations and formulations to fit the empirical evidence, it is obvious that the connection between unemployment and inflation from the historical point of view does exist For instance, in his examination

on the relationship between inflation and unemployment in South Africa from

1994-2015, Hemish Govera (2017) came to a conclusion that doubted the efficiency of the Phillips curve’s variation in explaining inflation However, the study did point out that The Phillips curve model remains an important part of the conception of how inflation and unemployment rate interact in an economy as adverse correlations

● Government expenditure

Perhaps it was Abrams (1999) who first proposed the idea of larger government size, which is the ratio of government expenditures to the total output of an economy, causing higher unemployment in an elaborate manner He discovered that government size is a reasonably strong predictor of unemployment rate based on a study of a group of OECD nations between 1984 and 1993, since there are various ways in which larger government size might raise this figure Since then, a number of related studies have arisen Recently, AbouElFarag and Qutb (2020) have observed government spending boosted Egypt's unemployment rate, which they attribute to greater interest, subsidy, and employee compensation spending Similarly, Yongjin (2011) looked at the influence of government size on economic development and unemployment from 1996

to 2006 in a sample of 32 advanced and 51 developing nations He reached the

conclusion that having a larger government had a favorable influence on unemployment, with the impact being considerably greater in developing nations than

in industrialized countries Furthermore, Government expenditure has a major impact

on unemployment, as claimed by Zulhanafi et al (2013) Increased government spending, such as capital spending to build infrastructure, raises output, which raises demand for elements of production, one of which is labor; therefore, the unemployment rate declines Conversely, if government expenditure diminishes, the process of producing goods and services (output) would be hampered, and demand for production components will fall as well, resulting in a rise in the unemployment rate

2 Factors affecting unemployment rate

● GDP growth rate

In his article, Amadeo (2020) defines GDP growth rate which measures the growth rate

of the economy It does this by comparing a quarter of the country's gross domestic product to the previous quarter GDP measures the economic output of a country GDP growth rate shows how fast or slow the economy is growing In fact, usually in countries with high GDP growth, the unemployment problem is often limited due to the large demand for jobs and the stability of social security

● Inflation rate

A.W.Philips was one of the first economists to find a way to prove an inverse relationship between inflation and unemployment This correlation is shown by the Phillips curve (1958) William Philips suggested that unemployment and inflation have

an inverse relationship That means if an economy wants to have a low unemployment rate, its economy must have a high inflation rate

● Population growth rate

According to the definition given by the General Statistics Office (2015), the General Population Growth Rate (referred to as the population growth rate) is the rate at which the population has increased (or decreased) over a period of time Population growth rate is one of the important measures determining the structure of the economy by age

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In countries with a young population pyramid, the demand and supply for labor is expected to be abundant, but it also poses urgent problems in solving the problem of unemployment

● Foreign direct investment

Investment is a contributing factor to the economic growth of a country, in which foreign direct investment (FDI) accounts for a large proportion Foreign direct investment is a form of long-term investment by an individual or company from one country to another by establishing production and business establishments That foreign individual or company will take over the management of this production and business establishment

FDI is one of the important resources to offset foreign investment, promote economic development for investment countries, especially developing and underdeveloped countries It is a fundamental channel for technology transfer between countries, promoting international trade In fact, FDI directly impacts both positively and negatively on the unemployment rate in different aspects

● Government final consumption expenditure

Government final consumption expenditure is an aggregate transaction amount on a country's national income accounts representing government expenditure on goods and services that are used for the direct satisfaction of individual needs (individual consumption) or collective needs of members of the community (collective consumption) Government's expenditure as a percentage of GDP plays an important role in decreasing the unemployment rate since they have the power to shape policies Governments should create policies that encourage their citizens to get knowledge and enhance their ability through creating a social program to be ready to work anywhere

II Theoretical framework

1 Theory of unemployment rate

● Definition

Unemployment, according to the OECD (Organisation for Economic Co-operation and

Development), is people above a specified age (usually 15) not being in paid [2]

employment or self-employment but currently available for work during the reference period

Unemployment is measured by the unemployment rate, which is the number of people who are unemployed as a percentage of the labour force (the total number of people employed added to those unemployed)

Unemployment can have many sources, such as new technologies and inventions, the status of the economy, which can be influenced by a recession, competition caused by globalization and international trade, policies of the government, regulation and market

- Seasonal unemployment: Occurs at seasonal jobs which require working in certain moments of a year

- Classical unemployment: Occurs when real wages for a job are set above the clearing level, causing the number of job-seekers to exceed the number of vacancies”

market-● Unemployment rate

The unemployment rate is probably the best-known labour market measure and certainly one of the most widely quoted by the media in many countries The unemployment rate is a useful measure of the underutilization of the labour supply It reflects the inability of an economy to generate employment for those persons who want

to work but are not doing so, even though they are available for employment and

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actively seeking work It is thus seen as an indicator of the efficiency and effectiveness

of an economy to absorb its labour force and of the performance of the labour market

The unemployment rate is calculated as follows:

Okun’s law was discovered by the economist Arthur Elvin Okun in the early 1960s It

is a rule of thumb which investigates the statistical relationship between a country’s unemployment rate and the growth rate of real gross domestic product (GDP)

The logic behind Okun’s law is indeed simple There is a positive relationship between output and employment since the more labor used in the production process, the more output being produced Total employment equals the labor force minus the unemployed persons, thus there is a negative relationship between output and unemployment In order to decrease the unemployment rate, hence, the economy must grow at a pace above its potential

More specifically, according to currently accepted versions of Okun’s law, to achieve a one percentage point decline in the unemployment rate in the course of a year, real GDP must grow approximately two percentage points faster than the rate of growth of potential GDP over that period So, for illustration, if the potential rate of GDP growth

is 2%, Okun’s law says that GDP must grow at about a 4% rate for one year to achieve

a one percentage point reduction in the rate of unemployment

The gap version of Okun's law may be written (Abel & Bernanke 2005) as:

Ȳ = 𝒄(𝒖 − ū)

- Ȳ = potential GDP

- Y = actual output

- c = factor relating changes in unemployment to changes in output

- u = actual unemployment rate

- ū = natural rate of unemployment

3 The Phillips curve

The Phillips curve is an economic model developed by Alban William Phillips, hypothesizing an inverse correlation between inflation and unemployment The theory states that the higher the inflation rate, the lower the unemployment rate and vice versa

Phillips hypothesized that when demand for labor is high and there are few unemployed workers, employers can be expected to bid wages up quite rapidly However, when demand for labor is low, and unemployment is high, workers are reluctant to accept lower wages than the prevailing rate, and as a result, wage rates fall very slowly A second factor that affects wage rate changes is the rate of change in unemployment If the economy is booming, employers will bid more vigorously for workers—which means that demand for labor is increasing at a fast pace (i.e., percentage of unemployment is decreasing rapidly)—than they would if the demand for labor were either not increasing (e.g., percentage unemployment is unchanging) or only increasing

at a slow pace

Since wages and salaries are a major input cost for companies, rising wages should lead

to higher prices for products and services in an economy, ultimately pushing the overall inflation rate higher As a result, Phillips graphed the relationship between general price inflation and unemployment, rather than wage inflation