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Application of Okun’s Law in The Economy of India During: 2008-2017 Payel Das*1; Rupkatha Mukherjee*2 Department of Economics Bijoy Krishna Girls' College, Howrah 5/3 M.G Road, Howrah-711101, West Bengal, India *1 [email protected]; *2 [email protected] Abstract: Losing job can be the most distressing economic event in person’s life. Most people rely on their labour earnings to maintain their standard of living. A job loss means a lower living standard in the present, anxiety about the future and reduced self- esteem. High is both an economic and a social problem. Unemployment is an economic problem because it represents waste of a valuable resource. The relationship between economic growth and unemployment has always preoccupied economists and politicians. To get the clear idea about this relationship economist are accustomed to refer “Okun’s Law”. The present paper inspects validity of Okun’s Law in the Indian economy. Further it uses econometrics tools to analyse the annual data of unemployment rate and real GDP growth rate for the period 2008-2017. The presence of statistically significant relation between unemployment rate and output growth rate indicates that unemployment influences real output directly as well as indirectly.

I. INTRODUCTION Now a days the world faces with major economic and financial problems, including among others the problem of unemployment and sufficient economic growth. Increasing the army of the unemployed is a very debatable issue everywhere around the world, not excluding even the developed economics. The economic growth and unemployment rate are the key indicators that simultaneously are monitored by both policymakers and public as they create a clear picture about economic development of a country. Moreover the linkage between unemployment rate and economic growth as a relevant macroeconomic issue cover a wide area of theoretical and empirical research. It is widely accepted view in economics that higher growth rate of the GDP of an economy increases employment and reduces unemployment. The theoretical proposition relating output and unemployment is known as “Okun’s Law”. This relation is among the most prominent in theory and has been found to be hold for several countries and regions mainly, in developed countries. In 1962, Okun announced for the first time his law, which will have significant political and economic consequences. In politics, it’s used to provide a minimum growth to stabilize unemployment and avoid popular overflows. In economics, it determines ideal values to achieve growth in order to guarantee a fixed or ideal level of unemployment. It allows then to estimate the goals of economic recovery. Okun's statistic shows a very strong correlation between changes in the unemployment rate and economic growth. Since the evolution of the production depends on the number of workers and productivity per worker, it was quite natural to verify the existence of statistical link between GDP growth rates and changes in the unemployment rate. Indeed, the unemployment rate for a given active population depends on the number of jobs. Verified in the case of the by Arthur Melvin Okun this relationship is strong enough for it to be presented today as a law: the Okun law. One of the largest problems that most developing countries face is unemployment. Unemployment can be regarded as the cause of poverty and economic dispersion. Okun’s law

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defines an inverse association between cyclical fluctuations in the output gap and the unemployment gap, where the values of coefficients vary from country to country and time to time. The subject of unemployment is a pervading challenge in developing economies. With the incidence of the global economic crisis, the increasing rate of unemployment extends even in developed nations of the world. The high incidence of unemployment implies inefficient use of the labour resources available in the country or region under study. However, full employment, one of the primary macroeconomic goals of the government of a country, implies effective maximization of its resources. Okun’s law is a key relationship in macroeconomics and it was proposed by the American economist Okun. In its original form, the relationship implies that a GDP growth by 3% leads to a 1% decrease in unemployment. It is the feature of supply side economics, as output increases in a recovery phase resulting in unemployed workers being hired. If output falls in a recession phase consequently workers are laid off from their jobs. According to the Global Employment Trends 2014 the unemployment rate has raised to 3.8%, last year it was 3.7%. With Population of 1.20 billion in our country the unemployment rate is increasing day by day. The problem of unemployment is rising but still many industries are facing the problem of skilled candidate for their company. The present study discusses the Okun law, unemployment and output or GDP in Indian context. II. OBJECTIVES OF THE STUDY The present analysis obtained the following objectives such as; 1. To study the employment growth and development in India. 2. To find out the relationship between GDP and unemployment in Indian Context.

REVIEW OF LITERATURE: After Okun (1962), others have followed justifying the existence of the Okun coefficient. These other studies have shown a remarkable stability of the coefficient in the United States, coefficient proves less stable when the estimates are carried out on other countries. Below we summarize many referred studies. Sheehan and Zahn (1980) majority of the works done on the relationship between unemployment and output growth focused on the development economies relativity, few have focused on unemployment and output growth in developing countries. He equally included inflation and real gross domestic product which are not supposed to enter into his model at the same time. As a result, this study tends to find out the magnitude of the impact of unemployment on output growth as well as captures the effect of structural adjustment programme. Barreto and Howland (1993) this study is an attempt to investigate the relationship between unemployment and GDP growth in Arab countries for the period of 1994 to 2010 using unit roottestes methodology and Pooled EGLS (Cross-section SUR). We find that the economic growth has negative and significant effect upon the unemployment rate it means that 1% increase in economic Growth will decrease the unemployment rate by 0.16%. Furthermore, the coefficient of Growth Rate of Population is significant at the 5% level and the sign is positive indicating that 1% increase in Growth Rate of Population will increase the unemployment rate by 0.37%. Prachowny (1993) it answer the question “Does Okun’s Law exist?” Yes, Okun’s Law can be applied to explain the Malaysian condition. Any attempts to reduce unemployment will result in increasing the growth rate of the GDP. But knowing the existence of these relationships alone will not solve the problem of unemployment in the country. The problem must be

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tackled from both sides of the labour market, from the job seekers’ point of view as well as from the employers’ point of view. Baker and Schmidt (1997) determined the Okun coefficient for a panel of OECD countries. They showed that the sensitivity of the job to growth was stronger in the 1980-1990 than in the 1960's. Clifford and Brian (1998) have discussed that if output and unemployment are cointegrated, and we equate Okun’s “potential” magnitudes with the stochastic trend or “permanent” component in output and unemployment (both defined in terms of the Beveridge and Nelson decomposition), then Okun’s coefficient can be interpreted as the cointegrating coefficient between the variables. In addition output and unemployment “gaps” can be calculated from the vector equilibrium correction model linking the two variables. Buescher and Muller (1999) showed that the unemployment sensitivity to output gap is affected by the volatility of the exchange rate. The argument was that the volatility of the exchange rate creates uncertainty and generates additional transaction costs. This cost has negative impact on exports and consequently on production and employment. They concluded that high volatility of the exchange rate tended to decrease the value of coefficient. Harris and Silverstone (2001) were discussed that unemployment is regarded as a serious problem faced most developed and developing countries and resulting socio-economic problems. The governments have given great attention to create job opportunities and reoperation the idle units to eliminate this phenomenon. Hubert (2005) showed that the Okun coefficient depends partly on degree of flexibility of the labour market. His study suggests that the link between the labour market (measured by the change in unemployment) and the goods market (measured by the output gap) is higher in countries with few restrictions on the labour market (flexibility ) compared to countries with a lot of restrictions (less flexibility). Malley and Molana (2008) have described that economy may move between ‘high-effort’ and ‘low-effort’ states. Our estimates of the threshold unemployment rate which separates these states are significantly positive for G7 countries; only German data exhibit tendency to being persistently in the high-effort state. They draw attention to the relevance of these findings for interpreting Okun’s law. It is worth noting that given the similarity between our definition of the threshold rate of unemployment and the NAIRU and the robustness of our empirical method for identifying and estimating a time-varying threshold rate, our approach complements those studies. Kreishan (2011) has investigated the relationship between unemployment and economic growth in Jordan through the implementation of Okun’s law, using annual data covering the period 1970-2008. The empirical results reveal that Okun’s law cannot be confirmed for Jordan. Thus, it can be suggested that the lack of economic growth does not explain the unemployment problem in Jordan. Bankole and Fatai (2013) checked the validity of Okun’s law in Nigeria, using the time series annual data for the period 1980-2008. They have employed the Engle granger co-integration test and FMOLS. The empirical evidences show that there is positive coefficient in the Regression, implying that Okun’s law interpretation is not applicable to Nigeria. Economou and Psarianos (2016) their study was examined the Okun’s Law in European countries by distinguishing between the transitory and the permanent effects of output changes upon unemployment and by examining the effect of labour market protection policies upon Okun’s coefficients. Okun’s Law is robust to alternative specifications. The effect of output changes to unemployment rates is weaker for countries with increased labour market protection expenditures and it is more persistent for countries with low labour market protection.

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III. REAL GDP GROWTH RATE, UNEMPLOYMENT RATE, OKUN’S LAW 3.1. Real GDP Growth Rate: Gross Domestic Product (GDP) is the market value of all final goods and services within a country in a given period of time. When GDP is valued at constant prices, we called it Real GDP. Real GDP is not affected by changes in prices; changes in real GDP reflect only changes in the amounts being produced. Real GDP reflects economy’s ability to satisfy people’s needs and desires. When economists talk about the economy’s GDP, they usually mean real GDP. Real GDP growthrate means the rate at which economy’s real GDP grows from one year to another. Since inflation plays a key role in the GDP of an economy, it is very important to ascertain the effects of inflation on GDP. As real GDP growth rate is inflation adjusted it is considered to be a better measure of growth rate. 3.2. Unemployment Rate: To know the unemployment rate first we divide population into four categories- ● Employed: These are people who perform any paid work, as well as those who have jobs but are absent from work because of illness, strikes, or vacations. ●Unemployed: Persons are classified as unemployed if they do not have a job, have actively looked for work in the prior 4 weeks, and are currently available for work. An important point to note is that unemployment requires more than being without a job—it requires taking steps to find a job. ●Not in the labour force: This includes the percentage of the adult population that is keeping house, retired, too ill to work, or simply not looking for work. ●Labour force: This includes all those who are either employed or unemployed. People with jobs are employed; people without jobs but looking for work are unemployed; people without jobs who are not looking for work are outside the labour force. The unemployment rate is the number of unemployed divided by the total labour force. 3.3. Okun’s Law: The most traumatic consequence of a recession is the accompanying rise in unemployment. As output falls, firms need fewer labour inputs, so new workers are not hired and current workers are laid off. We see that the unemployment rate usually moves inversely with output over the business cycle. This co-movement is known as Okun’s Law. Okun’s Law states that for every 2 per cent that GDP falls relative to potential GDP, the unemployment rate rises about 1 percentage point. This means that if GDP begins at 100 percent of its potential and falls to 98 percent of potential, the unemployment rate rises by 1 percentage point, say, from 6 to 7 per cent.

IV. METHODOLOGY Data sources: The data used in this paper consists of quarterly time series from 2008 to 2017. The data on the unemployment rate and economic growth are provided by the site of trading economics and World Bank. Econometrics Methodology: To analyse the relationship between unemployment rate and real GDP growth rate with the help of the data we use the econometrics tools i.e. the formula of OLS estimators, formula of

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correlation coefficient and also use the method of statistical inference in linear regression model etc. We estimate the regression line is Where α̂ &β̂ are the estimates of the parameters  Is the estimated value of Y, for any given value of X.? We cannot expect all observations to fall on estimated regression line  the actual and estimated value of Y will differ and this difference is denoted by-

We choose such values of α̂&β̂ which minimizes the sum squares of the error terms- I.e. we minimize F.O.Cs:

 ………………(1)

 ………………(2)

Equations (1) & (2) are known as normal equations. Solving these two the values of α̂&β̂can be obtained.

1. β̂ = 2. α̂= We obtained other formulas from different results relating to regression lines.

3. Sax =

4. SYY=

5. SXY = 6. T.S.S = SYY 2 7. E.S.S = β̂ SXX 8. R.S.S = T.S.S – E.S.S

9. r = From the estimation of the error variance we obtain-

2 10. s u=

Statistical Inference in the Linear Regression Model:

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Let us consider the null hypothesis H0: β = 0 This is to be tested against alternative β ≠ 0

Now, β̂ ~ N (β, )

Under H0, Since, is not known, the above test statistic cannot be calculated numerically. We may use in place of .

We have T.S.S= E.S.S+R.S.S

 Since, Cove ( ) = 0, E.S.S and R.S.S are independent.  We may construct the test statistic-

t= ~

Therefore, t =

We have , is unknown and unbiased estimator of is . Thus estimated variance-

Thus estimated S.E of

Thus t = V. DATA

Here we check the Okun’s Law of in case of India’s unemployment rate and growth rate of real GDP on the basis of the data of unemployment rate and growth of real GDP from 2008- 2017.

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YEAR UNEMPLOYMENT YEAR REAL GDP RATE (%) Annual Growth rate (%) (y) (x) 2008 4.12 2008 3.89 2009 3.75 2009 8.48 2010 3.54 2010 10.26 2011 3.53 2011 6.64 2012 3.62 2012 5.46 2013 3.46 2013 6.39 2014 3.41 2014 7.41 2015 3.49 2015 8.15 2016 3.51 2016 7.11 2017 3.52 2017 6.62

Source: www.tradingeconomics.com Source: www.data.worldbank.org

Date: 15/08/2018 Date: 15/10/2018

Time: 18:00 Time: 12:00

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VI. ANALYSIS To determine whether there is an evidence of the relation between two variables, we calculate- Correlation coefficient applying the formula, we get r = (Please refer to appendix 1).  There is negative relation between the unemployment rate and real GDP growth rate.  Okun’s Law is valid in case of India. When we consider hypothesis test for correlation coefficient (Please refer to appendix 2), we find that the tabulated value of sample is greater than 1.86, as the sample size is 10 and 5% level of significance is considered. I get the tabulated value from the table. Here I also get the result that unemployment rate is negatively dependent on real GDP growth rate. Here we also use the scatter diagram to visualize the negative relation between unemployment rate and real GDP growth rate. To obtain the best fitted line we use the formula of OLS estimators which minimize the error.

VII. CONCLUSION In this project we analyzed the correlation coefficient between economic growth and unemployment rate based on the Law of Okun (1962), for the case of India during 2008- 2017. We use econometrics tools and statistical inference to analyse the data. The presence of negative correlation between unemployment rate and real GDP growth rate implies the validity of Okun’s Law in India during the time period 2008-17.

After 1991 the government made many economic reforms to promote private sector to reduce unemployment rate. In the first stages of liberalization the public sector still remains the primary source of employment and the unemployment rate declines very slowly. The economic policies should be directed to encourage the employers to hire more workers during the period of expansions. In this case the government and policy makers should employ economic policies that are more oriented to structural changes and reform in labour market. As a result of this project, it is also recommended that the state should develop sustainable strategies and policies to sustain the economic growth and employment rate.

VIII. REFERENCE 1. Fatai, B. O., & Bankole, A. (2013). Empirical test of Okun’s Law in Nigeria. International Journal of Economic Practices and Theories, 3(3), 227-231. 2. Economou, A., & Psarianos, I. N. (2016). Revisiting Okun’s law in European Union countries. Journal of Economic Studies, 43(2), 275-287. 3. Baker, D., & Schmitt, J. (1998). The macroeconomic roots of high European unemployment: The impact of foreign growth. Economic Policy Institute (October). 4. Buscher, H. S., & Stirböck, C. (1999). Exchange rate volatility effects on the german labor market: A survey of recent results and extensions. 5. Barreto, H., & Howland, F. (1993). There are two Okun’s law relationships between output and unemployment. Crawfordsville, Wabash College. 6. Attfield, C. L., & Silverstone, B. (1998). Okun's law, cointegration and gap variables. Journal of Macroeconomics, 3(20), 625-637. 7. Giri, Prasanta Kumar and Jiban Banerjee, Statistical Tools And Techniques. Academic publishers; 5th editions 8. Harris, R., & Silverstone, B. (2001). Testing for asymmetry in Okun’s law: A cross- country comparison. Economics bulletin, 5(2), 1-13.

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9. Gabrisch, H., & Buscher, H. S. (2005). The unemployment-growth relationship in transition countries (No. 5/2005). IWH Discussion Papers.. 10. Kreishan, F. M. (2011). Economic growth and unemployment: An empirical analysis. Journal of Social Sciences, 7(2), 228-231. 11. Maddala, G. S and KajalLahiri, Introduction to Econometrics. Wiley (Indian Edition); 4th editions. 12. Mankiw, N. G. (2011). Principles of Economics. South-western Cengage learning. 13. Malley, J., & Molana, H. (2008). Output, unemployment and Okun's law: Some evidence from the G7. Economics Letters, 101(2), 113-115. 14. Okun, A. M. (1963). Potential GNP: its measurement and significance. Cowles Foundation for Research in Economics at . 15. Okun, A. M. (1963). Potential GNP: its measurement and significance. Cowles Foundation for Research in Economics at Yale University. 16. Prachowny, M. F. (1993). Okun's law: theoretical foundations and revised estimates. The review of Economics and Statistics, 331-336. 17. Samuelson, Paul A. and William D. Nordhaus, Economics, Mc GrawHill International Editions; 19th edition, pp. 595-600 18. Sheehan, Richard G. and Frank Zahn (1980).The Variability of the Okun coefficient. Southern Econ. 47: 488-497.

Appendix-1 2 2 YEAR Y X Y X XiYi 2008 4.12 3.89 16.974 15.132 16.027 2009 3.75 8.48 14.063 71.91 31.8 2010 3.54 10.26 12.532 105.27 36.32 2011 3.53 6.64 12.461 44.09 23.439 2012 3.62 5.46 13.104 29.812 19.765 2013 3.46 6.39 11.972 40.832 22.109 2014 3.41 7.41 11.628 54.908 25.268 2015 3.49 8.15 12.18 66.423 28.444 2016 3.51 7.11 12.32 50.552 24.956 2017 3.52 6.62 12.39 43.824 23.302 Total 35.95 70.41 129.62 522.75 251.43 Appendix-2 Calculation of Hypothesis test:- Now, we test, H0: β= 0; against H1: β<0

Under H0, t =

= = 2 From table tα,n-2 = t0.05,8 =1.86 Here Cal t < tab t  H0 is rejected under 5% level of significance  Y is negatively dependent on X.

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