Running Head : WHY UNEMPLOYMENT ALWAYS EXISTS?

Econ 4980

Grijalva Therese

Suyeon Noh

Why Unemployment Exists Forever?

- Relationship Related with International Trade.

Abstracts

International trade forces companies to be more competitive in the global marketplace. Job

outsourcing and the movement of production facilities to other countries that pay lower wages are

ways that allow companies to be more competitive in the global marketplace. A downside to

outsourcing is an increase in domestic unemployment. The purpose of this paper is to determine how

globalization has affected unemployment rates. To do this, five years of annual data from 2010 to

2014 was collected for 100 countries, including 34 OECD countries, was collected to examine how

trade openness at the country level affects unemployment rates. The standard measure of trade

openness, the sum of imports and exports relative to countrys GDP, is used to capture globalization or

trade liberalization. Although I am unable to reject my null hypothesis that trade openness does not

affect unemployment rates, OLS and fixed effects models show a positive relationship between trade

openness and unemployment rates. For every 1 unit increase in trade openness, unemployment rates

increase by about 0.001 to 0.017%.

Introduction

Outsourcing, Globalization effects

This research paper will discuss unemployment and how the trade openness affects to

decrease the unemployment rates. According to a research paper that comes from Stephan

and Luca (2017) , although OECD countries has developed a great growth since 1960s by

supporting education, there is still much unemployment rates. As this paper says, many

people are suffering from poverty in the world. Although education is improving throughout
WHY UNEMPLOYMENT ALWAYS EXISTS?

the world, some people still cannot get a job. Regardless of poor and rich countries, structural

unemployment is an effect of economic growth and structural change. This research paper

questions what the most important reason is for the unemployment. This paper expects that

trade is the significant factor with unemployment. In the past, the trade was not prominent,

but today all countries should trade each other. Since trade is the best scale to predict whether

the economy will go to recession or boom according to Adam Smith who describes that trade

is the best way to bring absolute advantage in production of particular goods, relative to each

other. In other words, the scale can help to predict the increase or decrease in unemployment.

More specifically, one of the basic standards to measure the economic status is trade balance.

When imports exceed exports, the trade deficit will occur; otherwise, the trade surplus will

occur. The change of economy can be measured by the price change; it can be shown as

inflation or deflation. As we know, if the economy is in recession, each company reduces the

production because people do not consume as they did, and they save the money; therefore,

company does not need to produce more than before. This phenomenon leads to

unemployment because the company wants to reduce the labor expenses not in need.

Therefore, the change of trade can affect employment opportunities for domestic workers.

The protectionism and outsourcing on trade can give us the huge relationship between the

trade and unemployment. If the government sets a trade barrier to protect its own industry,

what could be expected for unemployment? The purpose of the government is to protect the

local business in short term; however, it can bring the unemployment in the long term. How

about outsourcing? As mentioned above, the trade openness is the important business to grow

up the economy. A country can cut down the cost by importing in need with lower price and

exporting products that have an international competitiveness. However, if the government

prohibits that process, the industry that cannot fulfill the price competitiveness will be failed.

More specifically, if a company increases domestic prices because of trade restrictions, they
WHY UNEMPLOYMENT ALWAYS EXISTS?

will not longer be competitive, and they will lose business. Since labor is a derived demand

from products being demanded, if these business cannot compete, then they go out of

business, and workers will lose their jobs. Trade openness brings productivity and

competitiveness. Outsourcing is the best example to show us the huge positive impact of

trade openness on unemployment.

Finally, that protectionism to prohibit the outsourcing brings the structural

unemployment. Structural unemployment is the type of unemployment that happens by the

remodeling of a new structure of industry such as the growth of technology. However, it

sometimes happens by the irrational policy. The irrational policy is equal to the protectionism

of trade openness in this paper. As this research paper mentioned above, if the government

gives protection, each company loses the productivity and competitiveness, and it leads to

unemployment because the company does not want to hire more people and want to cut down

the labor fee. This paper will test whether a huge trade openness surely affects to reduce the

countrys unemployment change. Therefore, this paper will set the trade openness as a

focused variable. The main method is based on some existing literatures. This research will

test the correlation between unemployment and other variables by gathering the specific

percentage data for each variable. The data is based on 100 countries including 34 OECD

countries which stands for the organization for Economic cooperation and development for 5

years from 2010 to 2014.

Literature Review

In this section we will review some existing literatures related how much the trade

openness rates affects unemployment rates by summarizing each theory, hypothesis and

conclusion of literatures, especially focusing on the negative effect between trade openness

and unemployment. Those literatures may help to understand why each variable included on
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this paper are closely related with each other, and why they are important factors to reduce

unemployment rates.

Globalization impacts

Jafari (2012) tested the relationship between globalization and unemployment rates by

focusing on the existing test that comes from Romer (1993) which tested developed and

developing countries during 1990-1999 and 2000-2009. Romer hypothesis on his paper that

inflation is less in open economies based on the Phillips Curve because it is steeper in the

more open economies. However, higher economic globalization that derives more trade

openness decreased inflation rates since monetary expansion in an open economy is

accompanied by a depreciation of currency, raising costs for household and businesses. In

other words, the share of import is larger than the share of exports, the inflation increases

greater. In conclusion, of course there are positive and negative affect on unemployment by

trade openness which bring a higher inflation rates. According to this study, economic

globalization (trade openness) including such as FDI (foreign direct investment), stocks,

restrictions themselves like hidden import barriers, stubborn tariff rates and taxes on

international trade causes a negative effect on unemployment.

Government policy

Domenico (2010) contends the set of policies that favor liberalization in credit market

market such as central bank and some organizations related with monetary system including

IMF (International Monetary Fund) are negatively correlated with economic stability of

countries by affecting a change of output growth. This study is based on a change of global

recession in 2008 and 2009. Interestingly, countries with a higher income per capita shocked

the severe output loss when global recession occurs. The following controls are the reasons
WHY UNEMPLOYMENT ALWAYS EXISTS?

why countries that has a higher income per capita have experienced more severe output loss

during the global recession. According to this study, controls on openness, financial

development and risk taking by regulating the global monetary system.

There is another study of trade liberalization. Ana (1997) describes a change of

employment and wages by trade liberalization in the Mexico manufacturing. This study

focused on the rents by workers and firms. During the 1984-90, the average wage premium

for workers in Mexico was $25,000 per year that has a share of 25% of median annual

earnings. This rent was generated by trade protection. However, a change occurs when trade

liberalization set. During the 1985-1987, trade liberalization policy affected employment and

average wages by shifting down industry product and labor demand for a 3%-4% decline. Of

course the rents that is captured by firms and workers are also affected negatively.

Structural Unemployment

Choudhry (2012) asserts that the impact of policies and institutions for youth

unemployment can hugely reduce the youth unemployment rates. Youth unemployment refers

to the age group arranging 15-24 years. During 1980-2009, this study tested the

unemployment policies in high income OECD countries if total unemployment rate and youth

unemployment rates are affected differently by the unemployment policy. Such as the policy

regarding with GDP growth, inflation, real interest rate and education level definitely helped

to reduce unemployment, especially for youth unemployment

Infrastructures facilities

Francisco & Antonio (2004) find that international trade positively effects on

countrys productivity. It especially focuses on real openness than nominal openness by

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measuring it by multiplying openness and price level based on 1985. More specifically,

imports plus exports in exchange rates US$ relative to GDP denotes real openness.

Productivity is also affected by the size of countries in an economically and statistically.

In other words, the size of countries is equal to the size of infrastructure. In general,

developed countries have a better infrastructure than developing countries do. It means

productivity is commonly higher in developed countries than developing countries.

Therefore, this paper will divide the countries by developing and developed countries.

The reason to set OECD countries is as a dummy is shown on the paper that comes

from JIM LEE. JIM (1999) described the robustness of Okuns Law in his paper. He gathered

the data that comes from 16 OECD countries to evaluate Okun relationship based on the data

that comes from 16 OECD countries. Okuns Law is basically calculated by the correlation

between unemployment and output of country. Output of a country is related with a countrys

productivity and competitiveness. Therefore, it can hugely affect to unemployment. In

general, OECD countries are rich and have an infrastructure than other developing countries,

therefore the result of unemployment when we compare with other common countries has

definitely different default. That is the reason why this paper to set OECD as a dummy

variable.

Although all literature summaries are added, some research papers describe that

international trade can destroy employment, in other words, in the long run, unemployment

rises. In contrast, some papers suggest that trade openness reduces unemployment rates. On

the other hand, there is a strong negative effects on unemployment according to some

research papers. There are many different opinions on the relationship between

unemployment and trade openness. To test the close relationship, this paper will hypothesize

below.

Economic Theory and Hypothesis

WHY UNEMPLOYMENT ALWAYS EXISTS?

H0 = International Trade openness has no influence on unemployment rates.

HA = International Trade openness has a significant influence on unemployment rates.

I hypothesize null and alternative hypothesis. The core economic activity between

countries today is the trade. Generally, many developed countries already have a basic

infrastructure to support trading more efficiently in comparison to developing countries.

Importing the lacking resources and exporting the extra resources can make the economy

flexible, reducing leftovers. Trade openness is the way to vitalize an economy and it is the

way to create work. Trade openness can lead to economic prosperity since it makes leftovers

that are produced by one country can go to the place in need by trading. It finally leads to

create work. In other words, trade openness can decrease unemployment.

To find the strongly negative relationship between trade openness and unemployment

rates, this paper will describe several important theories; there is Neoclassical theory,

Ricardian model, Heckcher-Ohlin model, Production Function and Phillips Curve.

First of all, Neoclassical economics is the most prominent economic theory.

Neoclassical economics focuses on supply, demand, profit and satisfaction (Willam, Carl and

Leon, 1871). More specifically, the economy can be changed by the fluctuation of supply,

demand, profit and satisfaction. All factors are not static. They are always changed by the

international trade today. Especially, the change of stock market is the best reason to increase

or decrease supply and demand on trade. There is a good example paper to show us how the

stock market change can affect unemployment rates. Miao (2016) analyzed how the stock

market bubbles changes unemployment rates. According to this literature, the collapse of a

stock market bubble makes company investment lower and then makes the credit constraints

tighten. Unfortunately, this leads to reduced hiring.

Second, Ricardian model also can help us understand the negative relationship

between unemployment rates and trade openness (Ricardo, 1817). The modern version of the
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Ricardian model assumes that the two countries are there, and both of them produce two

different goods by using the same factor of production. In this model, the product of trade is

mainly labor force. As I mentioned above, trade causes competitiveness, and the

competitiveness makes an economic selection. The trade of labor is enacted by following the

profits. Therefore, trade will draw efficiency and put labor in need.

The third one is Heckcher Ohilin (H-O model) model (Heckcher, 1919). This

model describes the mathematical economics of international trade. Look at the Figure 2

below. The important implication of this model is that trade tends to bring factor prices into

equality. More specifically, if the comparative advantage happens between country A and B,

the trade tends to increase real wages. Therefore, this theory is a good one to help understand

the relationship international trade and economic change. Giray (2014) mentioned heckcher-

Ohlin model on his paper.

For the fourth, Production Function can also explain the importance of international

trade to reduce unemployment. This theory explains that an input definitely yields an output.

There is good literature to show the example. Francisco and Antonio (2004) describe that

international trade and productivity is positively related. By measuring the purchasing power

GDP which comes from the imports plus exports, the growth of purchasing power raises the

economic flows and then it leads to creating productivity. Finally, the increase of productivity

leads to reducing unemployment rates.

Finally, Phillips Curve is also closely related with the topic of this paper (Phillips,

1958). This curve describes the negative relationship between unemployment rates and

inflation rates. In other words, the higher rates of inflation make unemployment decrease.

Ahmad and Saman (2012) described that trade openness and inflation have a negative

relationship. This literature especially has estimated globalization index and inflation. More

specifically, globalization will decrease inflation because currency has a stability when trade
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happens. If inflation rates go down, the demand increases and supply decreases since

economy is in recession. therefore, a company will not hire many people to produce. This

leads to unemployment rates being higher. Basically, the rise of inflation is equal to the

growth of economy. Since inflation is lower, the economy will go to recession, and then

unemployment rates will increase.

Data Method

The purpose of this paper is to find the close relationship between unemployment

rates and trade in 100 country-level data. See the Figure 1 below that shows the trend of

Trade and Unemployment rates across time. To prove the relationship of them, this paper uses

country-level data including all 100 countries from 2010-2014. This paper is based on panel

data since it includes year and 100 countries. Among 100 countries, 35 countries are OECD;

it is the abbreviation of Organization for Economic Co-operation Development.

The data used from this paper come from International Labor Organization (ILO),

World Bank National Accounts Data (WBNAD), International Monetary Fund (IMF) and

Organization for Economic Co-operation and Development Data (OECD). For a detailed

summary of all variables, see the Table 1 below. All data was sorted by 100 country-level

data from 2010-2014 including 100 countries that is divided by 35 OECD countries and 65

developing countries. This paper is also structured as panel data.

Unemployment Rates

Unemployment rates refers to the share of the labor force that is available to work and

seeking a job without work. According to the hypothesis of this paper is that there is a

negative relationship each other. Although world technology is developing as time goes by,

there are still a huge unemployment.

WHY UNEMPLOYMENT ALWAYS EXISTS?

International Trade % based on GDP

Generally, trade is well known as the sum of exports and imports of services and

goods by measuring on share of gross domestic products. Gross domestic product is most

common source to measure growth of country. Higher GDP is equal to powerful economy.

Commonly countries which have a lower GDP is reckoned to be poorer than higher GDP

countries. Especially, the share of trade on GDP is standard of economic growth. In general,

vigorous trade brings wealth of country since it places a product in the right place, and trade

surplus products. This means that trade places a person in the right position. Therefore, it

leads to lower unemployment.

Age Dependency Ratio

According to the development of technology, a life expectancy is being longer when it is

compared with several decades. The limited work is being, but more working age groups

want to get a job. Basically, people describe the working age group by dividing the group

ranging 15-64. When we describe the unemployment, we basically focus on the working age

group, but this paper will analyze by the demographic aspect. Age dependency ratio is the

ratio that is divided by the dependent age group arranging younger than 15 or older than 64.

This data is based on the proportion of dependents per 100 working age proportion. The

reason to use the age dependency ratio instead of the working age is because age dependency

ratio can explain caregiving burden. More specifically, population growth between this age

dependency group brings caregiving burden to working age group arranging 15-64.

Moreover, technology development extended a life expectancy, and it extended working age

range over 64. Increasing of demand for work brings unemployment.

Consumer Price Index (CPI)

WHY UNEMPLOYMENT ALWAYS EXISTS?

The Consumer Price Index is a monthly measurement based on U.S. prices of

household goods and services. It represents a change of prices by two ways, inflation or

deflation. The prior one is equal to rising prices, and the other one is equal to falling prices.

Consumer Price Index easily fluctuates economic change. This variable is closely related with

inflation rates. Commonly, many research paper describes the relationship between

unemployment rates and inflation rates. Since inflation rates can explain economic growth of

one country well. However, more detailed and specific index is CPI because it is directly

related with real consumer who does economic activity. To access more detailed percent

change per year of a pattern of consumption of products and economic growth that is related

with unemployment, this paper will use CPI as an independent variable, too.

Econometric Methods

The dependent variable is unemployment rates and the independent variable is trade share of

GDP per year and country. This paper will use the basic OLS regression model. Among all

100 countries, only 35 countries are OECD. This paper will set countries as a dummy

variable if it is OECD or not. For example, dummy variable OECD1 = 1 for OECD countries,

0 otherwise.

The estimated equation is equal to below.

UNEMPi ,t = 0 + 1 T RADE i, t + 2 CPI i ,t + 3 AGED i , t + 4 OECD i ,t + i ,t

See Table 1 below to know what each independent variables stand for. means each

coefficient of each independent variables. i means each country including 100 countries. t

means the time arranging 2010-2014. is an unobserved factor that are not added on this

test, however has an influence to explain the relationship between unemployment rates and
WHY UNEMPLOYMENT ALWAYS EXISTS?

trade openness. If the result of this paper is different with expected one, there will be a lot of

Error term. Since this test used both of i and t, this is panel data.

Estimation and Results

The test is based on 95% of test. Therefore, if each t of independent variables is below 1.96,

the variable is reject to the model, otherwise, it is fail to reject.

The equation earned from those variables are equal to below. Empirical model

UNEMP=3.033964+0.0016938 T RADE+0. 0109776 CPI +0.0547168 AGED+1.331363 OECD

The OLS regression above shows the expectation of unemployment rates increase by

0.0016938%, 0.0109776% and 0.0547168% when each independent variables increase by 1

percentage. In other words, those independent variables have an influence on unemployment

rates by those specified percentage. The two predictors explain 4.4 percentage of the variation

of unemployment rates. Among those independent variable, only AGED and OECD were

reject. Only AGED and OECD are significantly influenced since the p-value of each were 0

and 0.006 each other.

Next model is the regression model that includes country level. The equation is below

UNEMP=16.53594 +0.0023 O PEN 0.0057 CPI 0.0748 AGED4.2169 OECD

If the empirical model includes 100 county level, the result is changed as shown above.

Unemployment rates is expected to increase by 0.0023 percentage when 1 unit of trade

inserted. However, unemployment rates decrease by 0.0748 and 0.0057 when each AGED

and CPI are inserted by 1 unit. When we consider the country, as the population of dependent

on working age ranging under 15 and over 64 affects to decrease unemployment rates. The

two predictors explain 95.58% of the variance of unemployment rates. In the case of OECD,

unemployment decreases by -4.2169% as I expected because commonly OECD countries

WHY UNEMPLOYMENT ALWAYS EXISTS?

have a basic infrastructure to produce goods and services, and it leads to create works easily

than other common countries. Therefore, when I regress including country level, the result is

different with the basic result not includes country level.

However, there was collinearity problem. This means the equation does not have a

significant influence when it considers country level. The reason is because there is an

omitted important independent variable that this equation does not have. In other words, there

is an important error term that not is included in.

Finally, I tested the regression model including time. The equation is below.

UNEMP=2.80501+ 0.00181T RADE+ 0.0159CPI +0.05378 AGED +1.34329 OECD

The result is also changed when the equation considers the year of countries. By times goes

by, unemployment rates increase by 0.00181%, 0.0159% and 0.05478% when each

independent variable is included by 1 percentage. The two predictors explain 4.5% of the

variance of unemployment rates. By the year, each of independent variables affect dependent

variable as shown. Only AGED and OECD are significantly influenced on unemployment,

and those are reject. For more detailed information of each variable, see Table 2 below. For

each of the regression value of each variable is below at Table 3.

Conclusion

The hypothesis of this paper was that there is a strong negative relationship between

unemployment and trade openness. In other words, if trade openness is vitalized in one

country, the country will create more works, and it leads to reduce unemployment. This paper

hypothesized trade openness as a focused independent variable. However, the regression

model had a different result. The more percentage age dependency group arranging under 15

and over 64 that depends on working age group is higher, unemployment rates were changed

hugely. Of course, there was a tiny influence of trade openness on unemployment. However,
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if this test focused on AGED not TRADE, the test would have a better result to show the

strong relationship.

However, there is no perfect study to prove the relationship between unemployment

and trade. The R2 was about 96% when the test includes country level into the regression

model. However, that model had a collinearity problem in it. This means the equation does

not have a significant influence when it considers country level. The reason is because there

is an omitted important independent variable that this equation does not have. In other words,

there is an important error term that not is included in.

To make the error of this research narrow, some relevant variable can be indicated.

Such as technology variable can be added. Although technology is growing up throughout

several decades, unemployment is growing up. People could think that the technology makes

human life easier, of course it makes sense, but it makes for people lose their work by

replacing all existing work to machine. It leads to grow up unemployment rates in the world.

However, this test is not useless. Since economy is changed by different variations,

each independent variable could not affect separately, however when I sort by them in a

group it could affect. Overall Significant theory can explain this phenomenon.

In conclusion, although the trade openness has a tiny influence on unemployment

because of a lot of different reasons, this study proposed the supplement for the next study.
WHY UNEMPLOYMENT ALWAYS EXISTS?

Figure 1.

Note: The Orange line is UNEMP, and the Grey line is TRADE. I drew the graph above by

excel including 34 OECD countries and 66 developing countries. As shown on the graph,

each of lines have a different peak. In other words, if orange goes to pick, grey goes down.

The data I collected show us strong evidence of the negative relationship between

unemployment and trade openness.

Tabel 1: Data Sources

Variable Description Source
UNEMP % Unemployment Rate International Labor Organization

TRADE Trade Proportion of GDP World Bank National Accounts Data

CPI Consumer Price Index International Monetary Fund

% Age Dependency Ratio ranged by Organization for Economic Co-

AGED
under 15 and over 64 on Working Age operation and Development Data
Organization for Economic Co-
OECD 1 if the country is OECD, otherwise 0
operation and Development Data

Tabel 2:
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Data Sources
Variable Min Max Mean Standard
Deviation
UNEMP 0.2 27.2 8.0036 5.144293

TRADE 0.1750032 374.7025 91.26139 55.46725

CPI 99.30779 298.5092 110.6937 15.35755

AGED 17.03121 112.6829 57.58231 17.03925

OECD 0 1 0.34 0.4741832

Independen Model 1 Model 2 Model 3

t Variable OLS Country FE Year FE
TRADE
0.0169 0.0023 0.0018
(0.40) (0.27) (0.43)
CPI
0.1098 -0.0057 0.0159
(0.72) (-1.09) (0.91)
AGED
0.0547*** 0.0748 0.0538***
(3.92) (-1.59) (3.82)
OECD
1.3314*** -4.2169* 1.3433***
(2.74) (-1.82) (2.75)
Adj. R2 0.04 0.96 0.05
Note: Values in parentheses represent t-values;
*p<0.10, **p<0.05, ***p<0.01