Validity of Okun’s Law in a spatially dependent and cyclical asymmetric context

Hasan Duran

doi:10.2298/pan190529003d

Abstract

The current article analyzes the validity of Okun?s Law and sizable distortions that can occur in the estimation when spatial dependence and cyclical asymmetric impacts are not considered, which is a concern commonly ignored by the existing literature. Primarily spatial panel regressions (SDM, SAR, and SEM) and nonparametric regressions along with specification tests are adopted in terms of the methodology (such as panel unit root tests, panel cointegration, Moran?s I and Geary?s C tests of global spatial dependence, spatial LM, and Hausman tests). Additionally, spatial heterogeneity and cross-regional variation in Okun?s Law are investigated by adopting geographically weighted regression, LISA (local indicators for spatial association), and local Geary?s C analysis. A panel of 26 Turkish NUTS-2 regions from 2004 to 2018 was analyzed. The results clearly revealed that failing to incorporate spatial proximity and asymmetric cycle impacts leads to the biased estimation of Okun?s coefficient, such that during the downswing years of the national economy, Okun?s Law holds robustly: unemployment increases quickly in response to a decline in output. In contrast, during upswing years, the size of Okun?s coefficient is relatively much lower. Moreover, spatial dependence and heterogeneity are sizably evident. Okun?s coefficient is demonstrated to vary significantly across regions that have different industrial and labor market characteristics. As a policy implication, it has been understood that the reduction of unemployment is more difficult than initially understood, as economic growth itself does not provide a solution during upswing periods. The necessary special and region-specific policies are discussed throughout the text.

Highlights

In macroeconomics literature, Okun’s Law has widely been recognized as a rule that indicates a direct association between output and unemployment
The last step in our analysis is to explore the regional differences in Okun’s coefficient, which will provide useful insights into the validity and geography of Okun’s Law
The main macroeconomic policy relies on targeting high economic growth triggered by massive domestic and foreign investments, international trade, and domestic demand

Summary

Introduction

Okun’s Law has widely been recognized as a rule that indicates a direct association between output and unemployment Okun, 1962; Robert J. It claims the necessity of a 3% output growth to reduce 1 point the unemployment rate (Okun, 1962). Severe methodological drawbacks must be considered in this field. Existing studies have often failed to consider the spatial economic interconnections among the regions of the country, the ignorance of which might lead to severe bias or the overestimation/underestimation of Okun’s coefficient (Reinhold Kosfeld and Christian Dreger, 2006; Christian Oberst and Jens Oelgemöller, 2013). Economic downturns and booms might have distinguished impacts on unemployment that must be considered when estimating Okun’s Law

Objectives

Findings

Discussion

Conclusion