Okun's Law Associations Research Paper Example

Next, we present a summary in chronological order of the recent articles regarding Okun´s Law in the context of Mexico.

Loría and Ramos (2007) estimate the dynamic relationship between unemployment rate and GDP by using annual data from 1970 to 2004 and relying on three time series structural models, namely, Kalman filter, Vector Auto Regression and Cointegration analysis. Their results confirm the validity of Okun's law for the Mexican economy. They estimate that the Okun’s coefficient ranges from 2.08 to 2.5 and the natural rate of unemployment based on the gap model is 14.65%. Their estimates of elasticity based on the trend model suggest that the employment elasticity of the output is 0.481.

Rodríguez and Peredo (2007) study the validity of Okun’s law by using quarterly data of real GDP and unemployment rate from 1987 to 2003. The authors estimate three specifications based on the original models proposed by Okun using the Kalman and Hodrick-Prescott filters. Their estimations for Okun’s coefficients are -2.47, -3.73 and 2.65.

Loria and Leobardo (2011) estimate the three Okun's equations using quarterly data from 1985 to 2006.They regress GDP on unemployment rate, and not the other way around. In doing so, they claim that it solves a serious econometric bias problem detected by Barreto and Howland (1993) in Okun’s seminal article. They empirically corroborate the validity of Okun’s law and find that the coefficients vary from 2.35 to 2.58. Additionally, they find that there is a bi-directional causal relationship between unemployment rate and output growth in all three specifications.

Loria et al (2012) using the first differences model analyze the relationship between the national female and male unemployment rates with the country's GDP and find that the male coefficient is twice that of the female coefficient. In addition, they also find evidence of bi-directional causality between the variation in unemployment (of men and women) and economic growth.

Islas and Cortez (2013) use a bivariate model to jointly estimate the permanent and transitory components of the output and unemployment rates with Kalman filter for the time-period 1987- 2008. The authors find an Okun coefficient of -2.868, a value they consider relatively low and attributable to factors such as rigidity in the labor market, the extensive informal labor market, limitations imposed by unions, changes in the use of productive capacity, technological progress, international migration, demographic changes, changing nature of labor contracts and outsourcing.

Loría et al (2015) estimate a Vector Error Correction Model (VECM) on quarterly data from 1997.3 to 2014.1, while incorporating labor market flexibility (defined as the ratio of temporary contracts to total employees in the formal market) to analyze its effect on the unemployment rate. The main findings show that the relationship between unemployment rate and GDP growth is negative (-0.12), coupled with the fact that labor flexibility increases the unemployment rate in Mexico, exhibiting an elasticity of 1.28.

Islas and Cortez (2018) use data from 1993 to 2015 and incorporate the effect of informal sector on the relationship between unemployment and output growth. They propose and estimate three models: a linear model (m1), a Markov regime switching model with fixed transition probabilities (m2) and a model with time-varying transition probabilities (m3). Their results indicate that m2 is preferable to m1, which suggests that the Okun's Law is not linear in the case of Mexico; Additionally, they find that the average cyclical unemployment rate is lower in expansionary regimes than in the recessive regimes, that is, a 1% decrease in cyclical output is accompanied by an increase of approximately 0.31% in unemployment, if the system is in a recessionary regime, while a 1% increase in cyclical output reduces unemployment by approximately 0.12% when the system is in an expansionary regime.

Alarcón and Soto (2017) estimate the opportunity cost of unemployment measured in terms of GDP with annual data from 2003 to 2014. They present the estimates of pooled, fixed effects and random effects models using a panel data of all 32 Mexican states. The main results show an Okun’s coefficient of -2.99, which implies that an increase of 1% in GDP generates a reduction of 2.99% in the unemployment rate. Additionally, they show the great diversity of parameters obtained in each of the Mexican states. For example, in states such as Tlaxcala (0.02), Chiapas (0.15), Oaxaca (2.88) and Zacatecas (2.98), the coefficient does not have the expected sign (it is counter cyclical), while for the state of Querétaro the Okun’s coefficient is -8.91, and for the state of Nayarit, it is -0.87.

Rojas (2019) uses a panel data of 32 Mexican states from 2005 to 2016. According to the estimates obtained from the random effects model, for each percentage point of growth of the output observed over the potential output, the unemployment is reduced by 0.13 percent. The author concludes that the value of Okun's coefficient indicates a labor market that is not very sensitive to the output growth, that is, a rigid labor market that does not allow the output variations to be reflected in the employment variations, which the author attributes to the rigid institutional framework that results in high rates of labor informality.

Santos et al (2020) estimate the three specifications proposed by Okun using time series models with quarterly data for the period 2005.1 to 2020.1. The first differences model shows that if the growth rate of output increases by one percentage point, the unemployment rate will decrease by 0.07 percentage points. The gap result indicates that if the gap between potential and observed output increases by one percentage point, the unemployment rate will increase by 0.12 percentage points, and that the natural rate of unemployment for Mexico is 4.23. In addition, the estimates of elasticity and trend models suggest that if the gross domestic product increases by 1%, the employment rate will increase by 0.16%, while the coefficient of time trend is also statistically significant, but shows an unexpected sign, since the Mexican economy has reduced its ability to generate jobs in the studied time-period.