Estimating The True Effect Of Ghana's Output On Its Unemployment

ABSTRACT
Unemployment is one of the major indicators that economists use to judge the general health of an economy. One important determinant of unemployment is a country's output. The Okun's Law postulates an inverse relationship between unemployment and output in a country. Estimating this effect with the method of Ordinary Least Square (OLS) in the presence of endogenous variable leads to invalid conclusions. The study, therefore, employed time-series data and the method of Instrumental Variable to estimate the true effect of Ghana's output on its unemployment. The results revealed that a one-percent increase in output leads to a more than one-percentage fall in unemployment in Ghana.

Keywords: Okun's Law, unemployment, Instrumental Variable, Output and Ghana.

1. INTRODUCTION
Unemployment have been very topical in almost every social and economic conversation around the world. It is one of the macroeconomic indicators that economists use to judge the general health of an economy. A reduction in unemployment means more economic resources are being employed which leads to the expansion of an economy. On the contrary, an increase in unemployment means shrinking of the economy which is characterized by low production. Okun (1962) postulated that a country's GDP would fall by two percent lower than its potential GDP given a percentage increase in unemployment. Baah-Boateng (2015) noted Ghana's total employment increased from 5.4 million in 1984 to 10.2 million in 2010 when annual growth rate increased from 2.5% to 5.2% over the period. Figure 1 depicts the inverse relationship between unemployment and output in Ghana between 1991 and 2017.

Several factors determine unemployment for an individual and for an economy as a whole. In Ghana, Baah-Boateng (2015) revealed that reservation wage, marital status, education and age determines the unemployment spell for an individual. Notable among the factors that determine unemployment rate for a country is its output. Okun (1962) empirically observed that there is a negative relationship between a country's output and its unemployment rate. Several works done in different jurisdiction and with different data and methods have confirmed this relationship between a country's production and its unemployment rate (Zaleha et al,2007; Karfakis et al,2011). As noted by Baah-Boateng (2015) and depicted by Figure 1, the relationship between unemployment and output in Ghana is not different from what Okun (1962) observed.

However, the output of a country is not independent in itself but determined by a plethora of factors which may be general or specific to a country. Chinnakum (2013) & Chien (2015) argued the accumulation of capital, technological advancement and increase in labor inputs such as its workers are the main determinants of output. Hall & Jones (1998) also found that institutions, rate of government consumption, and the private sector of a country are some of the factors that determines its output.

This leaves so much to be desired because how can we tell if it's the factors that determines output which influences the variations in unemployment or its indeed determined by a country's production?

Besides, a deeper understanding of Okun's law reveals that output of a country is determined along with its unemployment rate. The reason is that reducing unemployment rate means automatically increasing output. This situation presents a clear case of endogeneity and hence makes it difficult to measure the actual impact of an economy's output on its unemployment. This study therefore sought to estimate the true impact of Ghana's output on its level of unemployment by employing the method of instrumental variable.

Exchange rate was used to instrument the actual effect of Ghana's output on its unemployment. This is because exchange rates affect unemployment only through output but have no direct effect on unemployment. Bakshi et al (2015) examined the effects of exchange rate on unemployment but to achieve their goal they had to first establish the relationship between exchange rate and output before linking it to unemployment. Many other empirical works confirm the fact that exchange rate affect unemployment mainly through a country's output. That is the transmission mechanism of the effect of exchange rate on a country's unemployment is mostly through the foreign trade sector which essentially depends on their production.

Presentation and Interpretation of Results

Table 1: Summary Statistics of Variables

Data Source: World Development Index, 2018.
Table 1 summaries the statistics of the variables in the study. Unemployment and inflation both have an expected value of 5.45 and 19.65 respectively. These stresses the high level of unemployment and inflation in Ghana which has become a serious issue for policy makers to deal with. The mean of output was GHS 970,000 between 1991 and 2017. Exchange rate also had an average of 105.833 within the same period. Unemployment rate ranged between 2% and 10% whereas Ghana's output was within the amounts of GHS 631,000 and GHS 3,785,00 for the period studied. Also the variables under study are less volatile as the mean values are larger than their standard deviations.

Table 2: First-Stage Regression Results

Significant at 5% (**) Data Source: World Development Index, 2018.

Table 2 reveals that a unit increase in exchange rate will cause output to fall by 0.93167% and this is significant at 1% level of significance. The first stage regression showed exchange rate explained about 50% of variation in Ghana's output. This shows that the first stage regression is very strong as well as fulfilling the assumption of relevance in the use of instrumental variable. This is a good sign because there is no way exchange rate can be used as an instrument if it is uncorrelated with output.

Table 3: Instrumental Variable (2SLS) Regression Results

Significant at 5% (**) Data Source: World Development Index, 2018.

As shown by Table 3, a percentage increase in output will cause unemployment to fall by more than one percent. That is to say unemployment is very elastic to changes in output in Ghana. And it is significant at 1% level. It also shows that variations in Ghana's inflation and output explains more than 50% of variations in unemployment. This emphasize the importance of output and inflation as far as unemployment is concerned in Ghana. Unemployment goes up by 0.507% when inflation increase by one unit. This confirms the direct relationship between unemployment and inflation. The Hausman test statistic (T_H=0.554774) is greater than the P-value (p = 0.4639) which implies the rejection of the null hypothesis (H0). This means there is endogeneity and hence justifies the use of Instrumental Variable to estimate the true impact of Ghana's output on its unemployment.

CONCLUSION
Indeed, the use of OLS in the presence of endogeneity leads to just correlation coefficients but not causal effects. It was obvious from the forgoing that Ghana's output is endogenous and hence was hard to measure its true effect on the unemployment rate in the country. From the OLS regression results (Appendix; Table 1), a percentage increase in Ghana's output results in a less than one-percent fall in its unemployment rate. Thus one-percent increase in output results in 0.8488% fall in the level of unemployment. This implies that unemployment is not very responsive to changes in output in Ghana.

However, by the Instrumental Variable regression technique it came to light that a percentage increase in Ghana's output leads to more than one-percent fall in its unemployment. Specifically, one-percent increase in output leads to 1.03% fall in unemployment in Ghana. It is crystal clear that using OLS in the presence of endogeneity is not only misleading but biased which makes any subsequent policies based on its results invalid. In this case OLS was biased downwards and hence does not depict the true picture of the impact of Ghana's output on its unemployment.

The method of Instrumental Variable revealed that Ghana's unemployment rate is rather more sensitive to variations in its output and this is contrary to what was implied by OLS. Therefore, by the method of Instrumental variables, the true impact of Ghana's output on its unemployment have been estimated. Besides this study have confirmed the Okun's law in Ghana just as it was confirmed by Zaleha et al (2007) & Karfakis et al (2011) in Malaysia and Greece respectively.

This will help policy makers to know what to do to reduce the ever-increasing level of unemployment knowing the sensitivity of unemployment to changes in Ghana's output. Policies must be geared towards increasing Ghana's output since that will reduce unemployment by a much bigger percentage. Government must hence increase infrastructural projects to create a conducive environment for businesses to thrive. Policies such as tax incentives and subsidies which reduces cost of production for firms must be encouraged. This will go a long way to create jobs for the teaming number of unemployed people in Ghana.

REFERENCES
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Author: MPhil Economics Student||Department of Economics||Kwame Nkrumah University of Science and Technology (KNUST)||Email:[email protected]