Okun’s law in an emerging country: An empirical analysis in Indonesia

Abstract

Objective: Labor economics policy instruments, such as gross domestic product (GDP) and unemployment are persistent challenges for every country. As an emerging country, Indonesia seeks to reduce unemployment and increase gross domestic product. The aim of this study is to investigate the relationship between GDP and the open unemployment rate in Indonesia starting from 1987 to 2017.Research Design & Methods: The data were obtained from Indonesia’s Central Bureau of Statistics website. Moreover, the econometric model of the Granger causality and Structural Vector Autoregression capture the causality of GDP and the open unemployment rate.Findings: The Granger causality test suggested the open unemployment rate does Granger cause gross domestic product, but not vice versa. In line with the Structural Vector Auto-regression, there was a negative relationship between GDP and the open unemployment rate.Contribution & Value Added: This study is in line with Okun’s law which explains the more labor used in production will have implications for increasing GDP in the economy. It means this study presents evidence to support the existence of Okun’s law in Indonesia. Also, this study contributes to the literature in an emerging country by using the Structural Vector Autoregression model.