Does the Unemployment Invariance Hypothesis Hold in South Africa?

Abstract

The unemployment invariance hypothesis suggests that the unemployment rate will not be altered by changes in the labour force participation rate, productivity growth and capital stock in the long run. The evidence in this chapter rejects the relevance of the unemployment invariance hypothesis. We establish that the high unemployment rate does lower the labour force participation rate in the long run, consistent with the ‘discouraging worker effects’ channel. Furthermore, evidence shows that labour market reforms work via their influence on labour demand and wage settings. Moreover, price stability matters for the pass-through of loose labour market reforms to the unemployment rate, as high inflation expectations dampen the rate at which the unemployment rate falls due to loosening in the labour market reforms shocks. The rejection of the ‘unemployment invariance hypothesis’ suggests that policies which stimulate investment or improve innovation and technology or change the size of the labour force will have an effect on the unemployment rate in the long run. Hence, various policy interventions in the labour market can be used to mitigate the ‘discouraged worker effects’.