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The performance of relationship between domestic
domestic product and unemployment!
Agnieszka Ziomek
Economic Policy and Development Planning Chair
Poznan University of Economics
Poland
60-967 Poznan
Al. Niepodlegtosci 10
Tel. +48 061 856 95 56
E-mail: ziomek@novecil .ae.poznan.pl
Key words: domestic product, employment, economy climate, Polish economy, system
dynamics, unemployment.
ABSTRACT
The paper concerns the characteristic of conditions and processes, which
permanently influence the unemployment, as the result of domestic product
fluctuation. The economic reality determinates the character of the relationship
between the domestic production and labour market as the system. It signals, the
connection between the two variables depends not only on the domestic product
change, but also on a wide spectrum of factors. The variables, representing
factors are categorized into groups. Criterions of the devision are the affection
object - employer and employee and a size of the object. For the system analysis
has been applicated the system dynamics method. This method lets for an
investigation of a high number simultaneously operating and related processes,
which regulate reaction the unemployment on the domestic product changes.
INTRODUCTION
The issue of the relationship between the domestic product and unemployment
did not find the expression in the present economic literature. In the analysis on
the relation between frequent inflation and unemployment the connection
between unemployment and domestic product, is accepted as the assumption or
basement for the further consideration. The domestic product and unemployment
relationship seems to be reasonable, from the economic point of view. Okun's
Law states that, in general when the domestic product measured as GDP, or the
domestic production index rises, relative to its potential level, then the
unemployment (rate of unemployment) should decrease and otherwise, when
domestic product decreases, unemployment will rise [1],[2]. The change of
unemployment can be caused by a real, and also by an expected change in the
total income, or income of a company. When this change is caused by
expectations, the real change in unemployment exceeds the change in domestic
product, measured by any statistical indicator.
What is the reason for the existence of this relationship? The studied connection
has a positive influence on the economic development and growth. It means that
even if domestic product declines and unemployment rises the economy can
keep balance on the labour market in the long period. So, when an employer
effectively adjusts the labour factor to the market situation and the company's
capabilities, a domestic product decline less deep will be. Moreover, when these
adjustments are quickly performed it is possible to avoid high costs of the
surplus employment or loses not realised domestic production. Therefore, the
positive character of relationship derives also from the reduction of domestic
product gap. The domestic product gap decrease is possible, among other things,
through the rise in the number of employed and reduction of unemployment,
which is described as the unused labour force.
The permanent domestic product and unemployment relation has a stronger
effect on the social distribution of domestic income growth. So, the profit of the
income growth is not divided with the same algorithm. The last boom phase of
the American economy performance is the proper example. The growing income
relatively improved the situation of each social group. However, differences in
the obtained income get deeper, in spite of the economic policy, tended to reduce
a high differentiation [3]. So, when the relationship exists in the market
mechanism, it can be said, the conditions for the entrepreneurship development
are satisfied. It is difficult to say if the social profit will be gained. The situation
in the labour market improves, in the context of market equilibrium, but the
security and certainty of job falls. For the post Soviet societies it is the new style
of a life and work. The troubles with the acceptance of quick adjustments
regulated by the profit rate cause the lag in, or blockade a free performance of
processes. Nevertheless, positive connection for economic system will not get
stronger, because of the serious resistance to the transition in the labour market
conditions [4].
We have some types of changes in economy fluctuations, caused by different
reasons. It is regulated by cyclical economic behaviour, with the expansion and
recession phase, structural transition, seasonal and accidental fluctuation.
In the Polish economy, the type of cyclical behaviour has been systematically
studied since The Second World War. We can not claim that cyclical economic
behaviour started in 1990. Even under central plan totalitarian economy some
authors stated echo of specific cycles, in the context of investment processes [5].
In the last decade, these types of changes were a continuation of the previous
cycle with a deep crisis in 1900-1992. The variability of economic behaviour is
characteristic for the U.S. economy. In Poland this kind of symmetric domestic
product and unemployment changes is not crucial, because the intensive
restructuring, which is the most important task since 1990 disturbs the free
economic behaviour.
Since 1990, especially in the first four years, in Poland the structural
transformation process dominated the economy. Obviously, it was caused by the
transformation of economic system into a free market system. Significant
adjustments occurred in the industrial sector and less in agriculture. Services
developed very quickly, adjusting to the new conditions and absorbing in part,
the surplus of workforce.
A division of two types of changes in cyclical bahaviour and seasonal, in
statistical data does not give satisfactory results. So, more appropriate is an
analysis of real data, which is seasonally adjusted.
Graph | shows changes in the industrial domestic production index. This kind of
measurement is used to show fluctuations in performance more precisely than
the aggregated GDP coefficient. The reason for using this type of index is higher
sensitivity to the domestic production sector on fluctuations in overall activity.
Average monthly index, 1995=1
This makes it possible to show economic situation more precisely [6].
Graph 2 shows changes in unemployment level, seasonally adjusted.
160 40
150 0 y
2
ie
140 nu 2
8
130 10
z
o
120 0 g
§
110 1 §
U
£
100 Nu §
90 3 8
Yo
v
80 40 6
é
70 39 8
10 2 30 40 50 60 70 8 9 100 10 120
Graph 1, Index of industrial production (May 1991 - February 2000)
— Index ---- Trend ----- Difference
Unemployment (%)
25
20
15
10
10 0 10 20 30 40 50 60 70 80 90 100 110 120 130
Graph 2. Unemployment (% ) [January 1990-June 1999]
Difference between unemployment and trend value
— Unemployment% = ---- Trend ----- Difference
Source: Calculations based on Central Statistical Office data [6],
So we can ask, it is possible, that the relationship had taken place in the
formative market system. As we can suppose, the relationship will not be
significant. But the progressive reduction of obstacles for impulse flow will
accelerate and reinforce such processes like employing and dismissing.
Now let us look at the calculation results. Table 1. shows that the strength of the
relationship oscillates, as a measure of the correlation coefficient, in different
highly developed countries.
Table 1. The correlation between unemployment changes and increase of the
real GNP in period 1965 - 1993
Country Italy Germany | Great Britain
Correlation coefficient -0,45 -0,78 -0,52
Source: M. Burda, Ch. Wyptosz: Makroekonomics [8], p. 20
So, in the case of one country the feedback domestic product - unemployment is
stronger, in the other country is week. For Poland the correlation coefficient
between the number of differences (see the graphs 1,2) is -0,4. It means that
from the statistical point of view this connection level is not important.
This different relationship connection suggests, the existence of unemployment
reaction process depends on a composed feedbacks system. The process of the
domestic product - unemployment influence is possible, when the selected
factors transform the change in domestic product on processes responsible for
the change in unemployment. The system of the reaction process depends on:
- number of factors, which determine process performance,
- scale of factors influence,
- amplitude and frequency of the value variation.
Moreover, we can expect the relationship existence, when the basic and
additional conditions are realized.
The change (increase or decrease) of domestic product implies changes not only
in labour stock (number of workers). This change can also be reflected by
adjustment in sum of working time and earnings of workers. In the model a
mechanism of the unemployment reaction consists of economic processes which
directly determine a level of such variables as:
- rate of unemployment,
- number of jobs,
- period of job search,
- wage /salary.
Processes, presented in the model as the number of feedbacks, generally perform
in advantageous, or disadvantageous conditions. Moreover conditions form the
background for the existence of relationship.
The basic conditions are created by the political, economic and social system.
From the U.S. experience and Western Europe countries it derives that the most
favour political system is democracy, with the triple structure of the authority;
legislative, executive, jurisdiction. This kind of political system favours creation
and performance of the market system, which reinforce relationship.
However, pure market system does not exists in the world. The choice related
issue is the scale of modification of free market system. The mentioned choice is
usually determined by the definition of the State interference. As the U.S. and
Polish examples show, the level of the State interference is far differentiated and
has the significant influence on conditions creation for the relationship
performance. In the U.S. the level of interference can be described as "discreet",
in a free interpretation. The optimal economic policy seems to be watching and
taking care over the correct processes performance. It means that the authority
such as Government, Congress and Bank of Federal Reserve, through their
decisions correct the market mechanism, in order to attain the balance and
growth. In general, market participants, producers, consumers are responsible for
the welfare growth. The state through the power distribution creates
requirements of society. Perhaps because of this, the American society seems to
be very active in the participation in the market behaviour. This activity means
the permanent care over society's life status. It is necessary to mention a high
coefficient of the labour activity, self-employed, and the entrepreneurship in
relation to Poland and the European Union countries [9].
Among other things, from the historical reasons, the Polish economy
significantly differs from highly developed economies. The participation of a
State, measured as the level of income redistribution is by far wider than in the
U.S. We can explain it by the fact that the present transition requires the direct
initiative, activity and co-ordination of economic policy in order to restructure
the economy in different fields and the still intensive adjustments the domestic
production and services to the world market requirements. According to senior
professor W. Wilczynski and others, the state interference should be gradually
limited, while the necessary reforms are being implemented [10].
The duration of transition process shows that the synchronised reaction of the
domestic product and unemployment is less inevitable. When the U.S. market
mechanism creates the stable background for the reaction of unemployment, the
Polish system does not support the undisturbed processes behaviour. In general,
the conditions for strong feedback domestic product-unemployment are still in
creation phase [11].
Theoretically, in the case of domestic product to unemployment relation we have
the positive feedback. If a domestic product creates change in unemployment it
gives an impulse to implement changes in the labour market, but in the next
period the changed unemployment level affects the domestic product. So, in the
simple version of analysis the relation domestic product - unemployment will be
the positive loop with two variables and two negative feedbacks.
Scheme 1. Domestic product - unemployment loop
Teal domestic product ale of ulduployment
Scheme 2. Domestic product - unemployment feedback
real domestic product Tate of unemployment
When the above mentioned system forms favourable conditions, selected
processes cause the unemployment fluctuation. Generally, a change in domestic
product (p) does not derive from changes in unemployment (u), p # f(u), but u=
f(p).
The assumed loop (Scheme 1.) is more possible in theory, than in practice.
The problem of the domestic product variation in considered in theories of
growth, economic and political cycles, theory of expectations. Most of these
theories suggest that the domestic product causes the unemployment fluctuation,
(Scheme 2) [12].
The only one and rather rare situation of high unemployment and a low domestic
product gap, will probably decrease the domestic product. Through
intensification of the fiscal policy it is possible to obtain an increase in
redistribution effect. But the existence of unbalanced labour market, and the high
real income level can result from the external factors, such as an intensive
foreign labour inflow, or development of capital intensive industries. The
domestic product decrease can be caused by imposing higher taxes, which
indirectly forces producers to bear the costs of the labour supply surplus.
When the level of the state interference is low, possibilities for correction labour
market and social inequalities are narrow. In such a case, companies transform
the variation into domestic product on labour factor through the optimal and
rational adjustment of the domestic production scale and the whole size of plant
[13]. The scale of this transformation varies and depends on subject of the
analysis. In the case of a single company's reaction, changing unemployment
after, or during the domestic product fluctuation, is by far quicker and more
fluent than this reaction in the total economy. The lag in the rate of
unemployment reaction occurs, when workers are employed at more than one
workplace. Moreover, the number of jobs depends on the overall number of
births and deaths of enterprises. This clearly reflects the dynamic nature of job
market. The net effect of births partly explains the slow decrease of employment
and growth of unemployment. This difference is shown below, (Scheme 3.).
Scheme 3.: The lag in the total rate of unemployment reaction
Income,
Ri Ro
NAIRU Reduction of employment
R,: The total economy reaction,
R,: The company reaction.
The level of the connection between the domestic product and unemployment
changes in the period of observation. Therefore the relation is usually non-linear.
The correlation coefficient shows only the average level of this connection,
characteristic for a given economy. Therefore, for the more detailed
investigation of this relationship the model approach presented below, is
required.
The system and a single process are dynamic, because of the fluctuation of level
and frequency of factors. Factors, named in the model variables, are classified by
the object of effect and by size of the object. The classification of variables, in
accordance to these criteria is shown in Table 1.
Table 1.: Variables defining the reaction of unemployment assembled into
groups, in accordance to criterion of side and size of the object
Employee side reaction Employer side reaction
Unemployed person | Rate of unemployment |" elasticity of work. work-
. = labour market law,
* internal, spatial, conditions, period labour cost,
occupational of searching for Tamu Wases
mobility, work, number of trade unions
entrepreneurship, job offers, supply expected and present
self-employment, of work, profit of economic
= education, = relation of the activity, .
qualification, unemployment = domestic productivity,
= activity in benefit to the wage technological progress,
searching for or salary, net number of firms,
work "period of receiving |" level of income
the unemployment redistribution,
benefit, = investment and
the social security, consumption demand,
= effectiveness of the inflation rate,
active labour policy| _ Interest rate
Source: Autor's classification,
When the domestic product decreases, for the support of the relationship,
variables which describe an employer decision about delimitation of work-time
and number of employed, are more significant. The relationship will be
significant, when the labour law will allow adjustment of the labour stock. The
employers are at liberty in recruitment, so they should also have no difficulties
with the layoffs.
In the case of domestic product increase, the reaction should be concerned on the
workforce side. Mobility, labour activity, entrepreneurship are the important
variables then. The higher the value of these factors is, the higher the
participation of society in income creation.
The classification of variables concerning the size of the object divides factors of
the employed side into two groups. In the first variables group the object is
single person. Here we have variables: mobility (spatial, occupational),
education, entrepreneurship, self-employment and activity in search for work.
This kind of activity depends on the predisposition, but is also regulated by
situation in the labour market.
The second group of classification concerns variables determining the total
economy change in unemployment. These variables are: period of work search,
number of job offers, relation unemployment benefit to wage or salary, possible
to receive and appropriate to qualification, period of receiving the
unemployment benefit, the social security discouraging unemployed from the
legal employment, the overall supply of work, the effectiveness of the active
labour market policy.
In the group of employer's side factors, we have no variable determining the
reaction of single person. The way of reaction is rather common for all
employers because market conditions for firms are common for them.
The positive changes in the unemployment call out increase of the employment
probability. Why not in the number of employed? The unemployment and
employment are parts of the labour market. The sum of employed and not
employed, but searching job is the value of work supply. However, the change
of unemployment into employment is not equal. In Poland, besides the outflow
of discouraged people to a stock of passive labour force is the distressing large
grey area of employment, not visible in official statistics. This is the example of
phenomena of official statistics deformation which are typical in majority of
modern countries. The experimental investigation of grey area in Poland was
carried out The Central Statistical Office in 1995. In the group of 25.6 thousand
respondens, 8.6% worked in the grey area [14]. The change of employment into
unemployment is also related to uncontrolled unemployment increase. The
major part of the unregistered unemployment concerns agriculture. This sector
absorbs people who lost jobs mainly due to restructuring. Thus high
unemployment in agriculture consists of farmers and immigrants from cities.
One of the graphical presentation method for systems applied here is the system
dynamics method, used for the relationship's analysis. Created loops and
feedback describe the mechanism of process behaviour in a complex approach
[15].
The selected variables are of permanently character existing, in the system. So,
the influence is changed by the fluctuation of a variable value.
The definition of the system shape derives from studies, based on the Polish and
the American economies. The graphic model, presented below, sets the common
for free market economies composition and mechanism of the analysed
relationship.
The model is the fragment of total economy system. The attribute "dynamic"
means that the assumption ceteris paribus is not taken into account. All variables
change simultaneously. The fluctuation of one variables derives from the rest
variables changes [16]. The relationship between the domestic product and
unemployment is analysed only in the market system, with the limited State
interference. The society behaviour results from variables value of the employer
side. The application of system dynamics makes it possible to understand the
complexity of the real economy system and to answer the question, what factors
and processes are responsible for synchronised reaction of unemployment to
domestic product changes. The graphic scheme, presented below shows the way
of connection variables, mentioned above. These feedback's series can also be
considered to be the structure of process. The graph model of domestic product
— unemployment relationship performance, presents the above mentioned
concept of impulses flow. From the left side, we have the group of variables
(stock, flow and information variables) describing the domestic product sphere.
In this part of scheme the following issues are included;
= process of job creation,
= process of employment regulation in companies,
= income fluctuation, regulated by aggregated economic variables monetary,
fiscal policy and demand.
According to Scheme 2, variables of domestic product group should influence
the unemployment group variables. On the right side had been placed variables
unemployment group, describing the labour market system. Processes which
flow through variables mentioned group (see Table 1) are recruitment and layoff
processes. The behaviour of these processes is related to both, labour market and
domestic product factors. Therefore, the existence of the relationship between
domestic product and unemployment is possible. The domestic product variable
is regulated by a number of variables. Variables like taxes, number of firms,
labour costs, and etc. (see Table 1), influence the unemployment and transform a
sum of money into number of work places, employment and in the next into a
jobless people stock. The important regulator is a sum of income of economic
activity, which is included in model as the important factor, which regulates
decision concerning the labour stock in a company and increases the domestic
product stock. The level of domestic product can influence regulator income of
economic activity by existing business expectations and economic climate.
In reality the analysed relationship performs like a system. Therefore the system
dynamic method seemed to be an adequate one and helps to understand this
complex mechanism in a better way.
REFERENCES
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Wydawnictwo Naukowe PWN, Warszawa 1991;
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Gospodareza, [nr 3/2000];
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employment, Lubniewice 2001, paper under publishing procedure;
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region industry 1961 - 1966, Researches of Institute of Regional Economy
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[8] M. Burda, Ch. Wyptosz: Makroekonomics, PWE, Warszawa 2000;
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growth, Monthly Labour Review, [July 2000];
[10] W. Wilczynski: Way out of polish economy crisis, PWN, Warszawa-Pozan
1992.
[11] A. Ziomek: The state influence on the domestic product and unemployment
relationship in Poland, Zeszyty Naukowe, Akademia Ekonomiczna w
Poznaniu, paper under publishing procedure;
[12] R. J. Barro: Makroekonomics, PWE, Warszawa 1997;
[13] J.S. Franklin: Industry output and employment, Monthly Labour Review,
[November 1999];
[14] M. Kalaska, J. Witkowski: Jobs in the grey area in Poland 1995,
Gospodarka Narodowa, [nr1-2/1996];
[15] J. Polowczyk: Regulation mechanisms influence on economy plans
realization in system dynamics approach, Wydawnictwo Akademii
Ekonomicznej w Poznaniu, Poznan, 1992;
[16] M. Ruth, B. Hannon: Modeling Dynamic Economic Systems, Springer-
Verlag, New York, 1997;
The suplement 1
Graphic model of the relationship domestic product — unemployment
performance — point of reference for further discussion.
Mathematical model will be available on the request during the conference.
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