Econometric Analysis of Employment Rate based on New Economic Geography theory

* This was originally posted on 13th May, 2010:



Abstract:

This project attempted to create the model to indicate the significant factors influencing the employment rate in countries. As the author was sceptical about the traditional macroeconomic concepts the new economic geography theory approach is used. European countries are assessed in this project as Europe has a flexible labour mobility and is more convenient to assess the impact of language speaking ability in labour market than the USA where majority of people speak English. The Employment Rate Index (ERI), the index of employment, was based on the exponential of the employment rate subtracting the minimum employment rate in the data and then multiplied with 10 in order to make a symmetric variable (The raw data for the employment rate was very asymmetric). There are two explanatory variables are used; one indicates the employment opportunity in the other countries, and the other indicates the advantage to speak English in trade in both with other countries and within a country. Generalised Least Squares (GLS) estimates showed these two variables are significant enough to explain about the employment rate in a country.



1. Introduction:

This research was carried out to investigate to explain how the employment rate changes in terms of the New Economic Geography theory approach.



2. The reason why the data sets in European countries are used:

Europe has a flexible labour mobility as same as the USA unlike Asia and South America where people rarely change their job in their life. Europe is more convenient to assess the impact of language speaking ability in labour market than the USA where majority of people speak English. The global research encounters with lack of data set for the employment rate figure.



3. The Simultaneous Equation Problem in the traditional Macroeconomic theories:

The traditional macroeconomic theories claim that the employment rate is negatively correlated with the real wage. However, this assumption encounters with the simultaneous equation problem. The real wage rate is highly affected by the employment rate itself. For example, when the employment rate decreases, the real wage starts being depreciated in order to encourage employers to employ labour more. A part of Keynesian wage theory claims that when the employment rate decreases, the nominal wage should increase in order to encourage employees to work more.



4. The significance of using Geographic data:

The best variable explaining the unemployment rate is considered as the Gross Domestic Product (GDP). There is a high demand for productions when the GDP rises so that the demand for labour rises whilst there is a low demand for productions when the GDP falls so that the demand for labour falls. Nonetheless, John Maynard Keynes (1936) claimed that the productivity and the demand of labour is not always positively correlated. When the productivity rises, the production method can alter the labour incentive to the capital incentive. In addition, whenever the employment rate (or any variable representing it) is regressed on the GDP, it causes the endogeneity problem. Therefore, the GDP hardly becomes the best explanatory variable.

Alternatively, geographical aspects are recommended to be used as explanatory variables. Any variables used in economics tend to be measured by a common measure such as money. All variables introduced in IS-LM model are correlated each other. For example, the investment rate, the consumption rate, and the money supply are highly correlated with the productivity, and the productivity is highly correlated with these variables as well. On the other hand, the variables representing geographical aspects are not affected by any economic data generally speaking although these geographic data may affect the economic data. For instance, the geographic distance between cities and latitude (not used in this project but commonly used in the NEG theory) are not modified by any social scientific data sets.


Instead of analysing by the real wage effect inside the countries, the real wage effect in outside the countries is used to analyse the employment rate. Focusing on the graph below, rise in the real wage implies either decrease in the labour supply or increase in the labour demand. When the labour supply decreases in a country, there is a lack of labour supply or labourers in this countries are reluctant to work anymore. Therefore, there is more employment potential for immigrant labourers from outside this country. When the labour demand increases in a country, there is also more employment potential for immigrant labourers from outside this country. By contrast, fall in the real wage implies the opposite effect to the rise in the real wage by referring to the graph below.





This project used the matrix algebra (Explained in Chapter 6) to explain the employment potential in the other countries. The variable representing this is called the Wage Potential Index (WPI) in this project. In order to show this potential, the minimum distance between capital cities is used. As the countries are closer each other the effect of the real wage on employment in a country is stronger whilst as the countries are farer each other the effect of the real wage on employment in a country is weaker. The matrix algebra enables to asses this effect of all the countries surrounding the country assessed by this analysis simultaneously.



5. Shared Language provides more employment opportunities

The NEG theory also uses a variable (variables) representing the human capital index (indices). This project focused on the effect of shared language in both an domestic and international trade. For both non-skilled and skilled workers, language skill is necessary to find a job opportunity. This project focused on English as it is the most commonly used shared language as a shared language in international academic and business activities. As many people speak English in a country, people there find more employment opportunities in the other countries trading with this country. As both a country and the other country trading with have more people speaking English it is more convenient to trade each other.



6. Formulae used:


* The Annual Inflation Rates are the average of the five years.


7. Regression Analysis:

The time periods used are 1995, 2000, and 2005. The countries used are United Kingdom, Ireland, Netherlands, Belgium, Luxembourg, France, Switzerland, Spain, Portugal, Germany, Austria, Czech Republic, Slovak Republic, Italy, Malta, Slovenia, Greece, Cyprus, Finland, Sweden, Norway, Denmark, and Iceland. The reason why the number of time periods and countries is restricted is due to the lack of data sets in some other countries not introduced in this project. But, the author's previously carried out research on the real GDP per capita in a global data showed it did not make a difference between using all countries in a globe and using some representative of the economic regions in a globe. Therefore, the author was confident enough to use the data set able to use as much as possible to analyse the employment in this project.


The Generalised Least Squares (GLS) was used because one of the explanatory variable, the LPI, does not vary across the time (The author could not find a data for this varying across the time), the fixed-effect estimator based the Ordinary Least Squares (OLS) could not be used due to the multicollinearity between the dummy variables used in the OLS and the variable not varying across the time. The pooled OLS should not be used as the unit specific effect in the countries is significant. There is a certain level of the employment rate fixed over the time period. Therefore, the unit specific effect is included in the dummy variable "inside the error term". The regression result is as follows:



Both the WPI and the LPI are significant and positively correlated. The Breusch-Pagan test indicates that the random effect estimate based on the GLS should be used, and the Pooled OLS is not appropriate to use. The Hausman test indicates that the hypothesis claiming there is not an endogeneity problem cannot be rejected. According to what this table shows, the GLS estimates are essential to do this regression, and there is not an endogeneity problem so that this regression analysis is consistent.



8. Conclution:

Having analysed the employment rate, the real wage in the other countries, which represents the potential for labourers in one country to be employed, the geographical figures (the geographical distance represented in this project), and learning English are significant factors influencing the employment rate. This project proved that the NEG theory is able to explain the employment rate in labour market.



Data Sources:
Gleditsch and Ward (2001) Minimum Distance Data // Kristian Skrede Gleditsch
http://pwt.econ.upenn.edu/php_site/pwt_index.php
http://www.imf.org/external/pubs/ft/weo/2010/01/weodata/weoselgr.aspx
http://en.wikipedia.org/wiki/List_of_countries_by_English-speaking_population

Ethical/Philosophical Chart - Political Philosophical Compass

Chart Explaining Singaporean Economic Political Model

This chart is used for explaining Singaporean economic and political model with comparison to Anglo-Saxon style free market model with a small government and European social democratic welfare state model with a big government. Also, the idealistic world view created by European classical idealism is briefly introduced as an opposing side of the Singaporean model.

The vertical axis scales how big a government is in a model. Bigger government implies a central government role is significant to intervenue into economic and social issues and to administrate a huge scale of public sector. By contrast, smaller government implies government role is limitted for intervening into economic and social issues and more likely to let private enterprises and voluntary will of indivuals to look after public goods and services.

The holizontal axis scales the attitude toward equality. The right side puts priority on taking inequality for granted as a mean of promoting meritocracy stimulating a high aggregate productivity under an elitist socioeconomic structure. The left side puts priority on more egalitarian values where socioeconomic inequality is minimised with a high effort.

The modern Western politics tends to focus on the one dimensional spectrum based on the conflicting view between the European social democratic model regarding highly of a relatively egaritarian policy with a generous welfare state programmes and the Anglo-Saxon style free market economy promoting meritorcratic competition and optimising the productivity level under competition. The former has a relatively less confidence on entirely letting private individuals and market handling economy and social policy with their voluntary will and a relatively stronger confidence on relying on a government role looking after public. The latter has a strong condidence on a free market and private individuals in it voluntarily looking after both themselves and the others and is sceptical about government roll of intervening it.

Singaporean politics is so unique that it combines both a big government looking after a nation like the European welfare state model and a free market economy and meritorcacy like the Anglo-Saxon model. Singaporean model has a strong confidence on both a powerful government intervention and a voluntary force of free market and private individuals. The big goverment roll provides the public safety backed up by the strong law enforcement, the guardianship of harmonising citizens with multiculturalism and public education programme, and well-developed healthcare services. However, the big government of Singapore does not disrupt free market competitions based on free voluntary will of individuals and corporation, and it actually encourages it enough to establish such a strong meritorcratic socioeconomic structure accomplishing a miracle economic growth.

On the other hand, Singaporean model has some negative feedbacks from some endogenous citizens frustrated by the socioeconomic poliitcal system. Singaporean model applies the pragmatic attitude of adapting any existing socioeconomic policies not being constrained by ideologistic politics, and its utilitarianistic realism merely focuses on the national well-being as a hole. So, the rapid economic growth and the public safety are exaggerated meanwhile the frustration of relatively poor individuals and minority's view points tend to be overlooked.

Singaporean model is far from the classical idealism described by various European philosophical theories which aspires to invent an alternative which is not yet established but worth to attempt to establish. Producing an eccentric genius inventor like someone obtaining a Nobel prize is not a priority for Singapore. Although the voluntary will of individual is highly admired there, an individual sovereignty and her/his uniqueness are relatively more disregarded than strengthening the aggregate strength of a nation.

Overall, this comparison demonstrates more than one pathway of promoting small/big government and meritocracy/egaritarian policy. Singaporean model is refered to as an example of implimenting a unique pragmatical perspective policy as a successful and yet controversial example.

Economic Political Compass/Spectrum

From economists' point of view, the economic scale based on goverment size (big v.s. small) in Political Compass is not useful to explain the real impact of policy on economy. In the real world economy, government size does not seem to matter whether a nation/community impliments elitist or egalitarian policy. The real matter is the intentional objective whether a government or a community aspires to accomplish.

Both capitarist economy based on a severe competition of private enterprises and socialist economy mainly operated by a government central planning support meritocracy establishing an efficient mechanism of sustaining productivity and a rigid hierarchy maintaining a stable social order. By contrast, more egalitarian economies may keep a feasible balance of government size and freeness of private enterprises, and this balance varies across different geographic and ethinic characteristics.

Singapore and South Korea encourage a high economic freedom of private business competition and also maintain a roll of big government propping up public goods and social order. In these nations, the big government sustaining the stable social order and bearing the responsibility of administrating public sectors assist growing the private businesses and the furthermore economic freedom. In addition, Singaporean and South Korean economy keeps their capacity of controlling business cycles. While remaining the relatively free market economy, their big and proactive government is prepared for mitigating either overheated or hard-falling of their business cycle.

Modern continental European nations tend to focus on encouraging more egalitarian values and freedom of expressions more than economic efficiency. Their government roll is bigger than the U.S.A. and the U.K. but smaller than both socialist and the aforementioned emerging Asian nations. In particular, the current Eurozone seems to be afrain of an excessive government intervention into its economy because of the predicted excess cost of implimenting it in such a huge economic zone with its unstable fiscal and regulatory structure which is still not well integrated. This unstability is also the cost of accomplishing their ideal of European integration with an egalitarian value.

Scandinavians are far more famous for accomplishing egalitarianism while maintainig their reasonably strong economy as well as their political and social stability. They still keep their proactive capacity relatively more than the Eurozone because they are not in a part of a massive complicated economic zone like Eurozone. But, Scandinavian economic policy is not so much proactive because they have been historically famous for their conservative macroeconomic policy reluctant to spend government expenditure for economic stimulus. Instead of spending for incentivising the macroeconomic performance, they put priority on sparing their expenditure for their generous welfare programming for their egalitarianism.

Judging from these examples, the key scales of distinguishing economic policies should be the "efficient but oppressive v.s. egalitarian" axis and the "proactiveness v.s. passiveness" axis instead of a simple big v.s. small axis. An efficient but oppresive policy with a proactive attitude focuses on sustaining a remarkable economic performance while their stratified elitism may increas a frustration of subordinate citizens. An egalitarian policy focuses on spending for their egalitarian ideals while sacrificing their efficiency of stimulating their economic performance.

There is an notorious policy which should be called the "efficient but oppressive and passive". This one has been frequently seen in various primitive developing nations and the USSR style communist nations. Their passiveness comes from their lack of economic ratinale of either not understanding economics or intentionally abandoning economic well being for their eccentric dogma. The egalitarianism is also ignored because the minority ruling class controlling their dogmatic state hold their ultimate power of controlling the rest of people.

The "egalitarian and proavtive" policy hardly appears in the real world but Islamism often indicates the economic policy in their teaching. Islam is famous for involving teaching about economy in their religious teaching which claims for letting money following without not stuck in one place and being generous to give away for saving deprived ones. This policy suggests for a volutary religious will of individuals instead of a modern government intervention for implimenting egalitarianism so that this is another remarkable example of something the "big v.s. small government" does not seem to explain.

Rosh Hashanan! Happy Jewish New Year!

Khavar Yakar, Rosh Hashanan!

Dear friends, Happy Jewish New Year!

La Vietnamienne