Relationship Between Gdp And Unemployment In Pakistan Economics Essay

Modeling the relationship between GDP and unemployment for Okun ‘s jurisprudence particular to Pakistan during 1976-2010. Okun ‘s jurisprudence postulates a negative relationship between motions of the unemployment rate and the existent gross domestic merchandise ( GDP ) . This article investigates the nexus between the existent GDP growing and unemployment, as described by Okun ‘s jurisprudence. For this intent we have used clip series one-year informations during the period 1976 to 2010 and used unit root trial and lest square method to happen the relationship between GDP growing and unemployment in Pakistan. The empirical analysis shows that a rise of one per centum point of unemployment is associated with a diminution of 0.36 per centum point of existent GDP growing.

I. Introduction

Okun ‘s jurisprudence postulates a negative relationship between motions of the unemployment rate and the existent gross domestic merchandise ( GDP ) . This empirical relationship is a major portion of every traditional macro-model as the aggregative supply curve is derived by uniting Okun ‘s jurisprudence with

the Phillips curve. It is the characteristic of supply side in macroeconomics, as end product additions in a recovery stage – unemployed workers are hired, as end product falls in recession – workers are laid off from their occupations. In world, though, Okun ‘s jurisprudence is a statistical relationship instead than a structural characteristic of the economic system. As with any statistical relationship, it may be capable to alterations in an ever-changing macro economic system.

“ In earlier surveies, Okun found that the relationship was approximately 3 to 1: that is 1 point of unemployment for every 3 points of GDP spread. However, more recent informations and more advanced econometrics techniques suggest that the 2 to 1 ( or possibly 2.5 ) pitching ratio between end product and the unemployment rate is more representative for recent periods ” . [ Samuelson and Nordhaus, 15th Ed. ] .Irfan Lal, Sulaiman D, M. Anwer Jalil and Adnan Hussain 2010, find long tally relationship between variable and error rectification mechanism for short tally dynamic by utilizing co integrating technique. They found that Okun ‘s jurisprudence reading may non be applicable in some Asiatic developing states including Pakistan.Christian Pierdzioch, Jan-Christoph Rulke and Georg Stadtmann, 2009, found a important negative relationship between the expected growing rate of existent end product and alteration in the unemployment rate.Dany Lang and Christian de Peretti 2009 pointed out that there is a important relationship between fluctuations in unemployment and growing, the most of import yesteryear growing daze exerts an influence on the current unemployment rate.Jim Malley, Hassan Molana 2008, found that to follow the consequence of typical demand side macroeconomic policies targeted at cut downing unemployment depends on which province prevails, and that such policies are improbable to give the expected consequence when the economic system is in a low-effort state.Jose Villaverde, Adolfo Maza 2008 argued that, the quantitative values of Okun ‘s coefficients are rather different, a consequence that is partly explained by regional disparities in productiveness growing. These differences imply that, when it comes to policy issues, conventional sum demand/supply direction policies should be combined with region-specific policies.Knotek ( 2007 ) pointed that there are three ways of happening the Okun ‘s Law. First, to captured the alterations in the unemployment rate from one one-fourth to the following one-fourth i.e difference version. Second, the spread version captures unemployment to the spread between possible end product and existent end product, which was besides applied by Thirlwall ( 1969 ) in ciphering natural rate of growing and the 3rd, the dynamic version implied the past end product, current of end product and past unemployment to impact the unemployment. Last but non least, the production-function version which combined the theory of production map ( labour, capital and engineering ) with the spread version of Okun ‘s Law.Mohd Noor, Zaleha. , Mohamed Nor, Norashidah and Abdul Ghani, Judhiana ( 2007 )

found the being of Okun ‘s jurisprudence in Malaysia with coefficient of -1.75, important at 1

per centum degree which is lesser than the original Okun ‘s law.Paramsothy Silvapulle, Imad A. Moosa, Mervyn J. Silvapulle 2004 found that the short-term effects of positive cyclical end product on cyclical unemployment are quantitatively different from those of negative 1s. Besides proposed that the output-unemployment relationship as represented by Okun ‘s jurisprudence is asymmetric. Leopold Soegner and Alfred Stiassny 2002 proposed that states with a extremely protected labour market really exhibit a low reaction of employment to GDP fluctuations ( chiefly due to labour stashing ) , while the continuity in the unemployment rate is stronger for these countries.Lee ( 2000 ) supports the cogency of Okun ‘s jurisprudence, but non the hardiness of Okun ‘s jurisprudence application of other OECD states, besides added that the relationship of the Okun ‘s Law is non every bit robust as reported by Okun in his determination. Okun ‘s ( 1962 ) findings pave an of import background on the analysis of the relationship between end product growing and unemployment. The initial determination of Okun ‘s jurisprudence predicts that if end product were to increase by 3 per centum point, it will cut down the unemployment rate by 1 per centum. This was agreed by Weber ( 1995 ) but he found smaller value of coefficient if dynamic specifications were applied.

Model Specification

The initial signifier of Okun ‘s can be written as:

I‰ ( U* – Uracil ) = ( Y – Y* ) / Y* — — — — — — — — — — — — — — — — — — — — – ( 1 )

Where U is the unemployment rate, Y is the existent GDP and an asterisk represents possible or natural rate degrees of the variables. The Above inquiry provinces that for every per centum point the unemployment is below the natural rate, GDP is I‰ % above possible GDP.

In order to through empirical observation gauge Okun ‘s jurisprudence, giving the fact that U* and Y* are hard to gauge we will utilize a decreased signifier of the old equation

To deduce the growing rate version, we foremost expand equation 1:

I‰U* – I‰U = Y / Y* – Y*/ Y* — — — — — — — — — — — — — — — — — — — — – ( 2 )

Now we differentiate Eq ( 2 ) w.r.t to all variables. In order to simplify our analysis we will see Y* as a changeless, Stating the possible GDP is non altering on the short term. Frankincense:

I‰dU* – I‰dU – dysprosium / Y* – dY*/ Y* — — — — — — — — — — — — — — — — — — — — – ( 3 )

Besides, we assume that the alteration of the natural rate of unemployment dU* = 0. Using this premise and rearranging we obtain:

dysprosium / Y* = – I‰dU + dY*/ Y* — — — — — — — — — — — — — — — — — — — — — ( 4 )

The natural existent GDP growing rate is normally close to the existent growing rate. Therefore we can come close dY*/Y with dY/Y. This alteration can be invalidated on the short tally but on the long tally it is consistent. Thus

dysprosium / Y = – I‰dU + dY*/ Y* — — — — — — — — — — — — — — — — — — — — — — ( 5 )

The natural existent GDP growing rate is equal to the possible GDP growing rate less the merchandise of Okun ‘s jurisprudence coefficient and the alteration in unemployment rate. Using ordinary least squares Okun has obtained I‰ = 2 and dY* / Y* = 3. Therefore possible GDP growing rate is about 3 per centum points while a rise in unemployment by 1 per centum point will take down existent GDP growing rate by 2 per centum points.

Testing the Validity of Okun ‘s jurisprudence for Pakistan

In order to through empirical observation prove Okun ‘s jurisprudence for Pakistan, we have used one-year informations for existent GDP growing and unemployment in the period 1973-2010. The beginning of the information is World Bank Dataset ( WDI ) and State Bank of Pakistan.

Graph 1: Real GDP vs. Unemployment

Graph 2: DY/Y V DU/U

The graph suggests that higher values of economic growing can be associated with lower values of unemployment growing rate.

To look into the relationship between the growing and unemployment rate, preliminary trials were made in order to choose the best arrested development theoretical account. First measure was to prove whether the variables are stationary by running ADF and PP trials. The consequences are shown in the Table below:

Table 1: Stationary trials for GDP growing rate ( dy/y ) and unemployment growing rate ( du/u )



















Both Augmented Dickey-Fuller trial ( ADF ) and Phillips-Perron ( PP ) trial confirmed that the variables are stationary in degree. Besides the dependant variable ( DY/Y ) the partial autocorrelation map showed dependance in the first two slowdowns ; to acquire better arrested development consequences we included in the arrested development the first two AR footings. After running several arrested development equations which included different slowdowns for the unemployment growing rate it was taking the one which consider du/u ( -2 ) based on statistically significance standard. Therefore the equation found to depict the best relationship between the unemployment and growing rate on significance and information standards was:

Dependent Variable: DY/Y

Method: Least Squares

Sample ( adjusted ) : 1977 2010

Included observations: 34 after accommodations

Convergence achieved after 12 loops



Std. Mistake


Prob.A A






DU/U ( -2 )





AR ( 1 )





AR ( 2 )







A A A A Mean dependant volt-ampere


Adjusted R-squared


A A A A S.D. dependant volt-ampere


S.E. of arrested development


A A A A Akaike info standard


Sum squared resid


A A A A Schwarz standard


Log likeliness


A A A A F-statistic


Durbin-Watson stat


A A A A Prob ( F-statistic )


The coefficient of dU is around -0.36 and is statistically important. A rise by one per centum

point of unemployment will cut down existent GDP growing by 0.36 per centum points with a hold of 2

slowdowns. The intercept can be interpreted as possible GDP growing ; so the degree of economic growing

which will non bring forth rising prices is below 2.83 per centum points. The Durbin-Watson statistic is around 2 which mean that there is no autocorrelation in the remainders. The correlogram of remainders confirmed the absence of autocorrelation.


The importance of Okun ‘ jurisprudence lies in its deductions for economic policy. The correlativity between existent GDP growing and unemployment is really of import for policy shapers in order to obtain a sustainable rise in life criterions. If the GDP growing is above its natural degree, policy shapers will make up one’s mind non to intensively advance the creative activity of new occupations in order to obtain a sustainable growing rate which will non bring forth rising prices.

The incline of unemployment in Okun ‘s jurisprudence in around -0.36 and possible GDP growing is around

2.8 per centum points and the variables are negatively correlated as predicted by the theory. The methods used and the consequences presented in this paper supply penetrations into the effects on the unemployment rate of divergences of national end product. This grounds supports the consequences of other writers for different series and periods, which allows us to utilize it as a good instrument of analysis and prediction of the economic rhythm ; allows us to gauge the forfeit rate of long tally unemployment ; and moreover, shows that the economic policy must concentrate by all agencies in avoiding fluctuations in growing and at the same clip cut downing unemployment, because this manner it will excite growing in the long tally.