Sustainable Employment in Developing and Emerging Countries: Testing Augmented Okun’s Law in Light of Institutional Quality

Abstract

This article is motivated by the recent debate raised on Okun’s Law regarding the divergence of the magnitude of Okun’s coefficient across countries and time horizons, its asymmetry and non-linearity, and the methodological issues associated with the estimate of this law. We tested the proposition that institutional quality—as measured by governance indicators—can explain this divergence and non-linearity. We estimated an augmented version of Okun’s Law showing the non-linear responsiveness of unemployment to fluctuations in GDP in the presence of institutional quality in a sample of 88 developing and emerging countries over the 1985–2019 period. Estimates are run using the 3sls regressor. We found evidence confirming that the responsiveness of unemployment to changes in output is all the more remarkable in countries with stronger institutions. We show that improving the institutional environment—as proxied by Government Effectiveness (GE), Control of Corruption (CC), Regulatory Quality (RQ), the Rule of Law (RL), and Voice and Accountability (VA)—is as important as increased economic growth in the strategy of reducing unemployment and reaching full employment in these countries, which is one of the 17 Sustainable Development Goals (SDGs) issued by the United Nations.