The Relationship between Unemployment and Output in Post-communist Countries

Abstract

Unemployment is still disappointingly high in most Central and East European countries, which may be a reflection of the ongoing adjustment to institutional shocks resulting from systemic transition, or may be caused by high labour market rigidity or aggregate demand that is too weak. This article investigates the dynamics of unemployment and output in those eight post-communist countries which entered the EU in 2004. We use a model related to Okun's Law; i.e. the first differences in unemployment rates are regressed on GDP growth rates. We estimate country and panel regressions with instrument variables (TSLS) and apply some tests to the data and regression results. We assume transition of labour markets to be accomplished when a robust relationship exists between unemployment rate changes and GDP growth. Moreover, the estimated coefficients contain information about labour market rigidity and unemployment thresholds of output growth. Our results suggest that the transition of labour markets can be regarded as completed since unemployment responds to output changes and not to a changing institutional environment that destroys jobs in the state sector. The regression coefficients demonstrate that a high trend rate of productivity and a high unemployment intensity of output growth have been observable since 1998. Therefore, we conclude that labour market rigidities do not play an important role in explaining high unemployment rates. However, GDP growth is dominated by productivity progress and the employment-relevant component of aggregate demand is too low to reduce the high level of unemployment substantially.