Applied Econometrics

This document provides study material and solved assignments on Applied Econometrics. It explores the relation between unemployment and factors like GDP growth, FDI, export, and inflation. The document also includes hypotheses, estimation results, and descriptive statistics. The data is collected from World Bank data dictionary.

Running head: APPLIED ECONOMETRICS
Applied Econometrics
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1APPLIED ECONOMETRICS
Table of Contents
1. Introduction..................................................................................................................................2
1.1 Background of the study........................................................................................................2
1.2 Problem statement.................................................................................................................2
1.3 Research aim..........................................................................................................................2
1.4 Data source............................................................................................................................2
1.5 Research question..................................................................................................................2
2. Literature Review........................................................................................................................2
2.1 Relation between unemployment and GDP growth..............................................................2
2.2 Relation between unemployment and FDI............................................................................3
2.3 Relation between unemployment and export........................................................................3
2.4 Relation between unemployment and inflation.....................................................................4
2.5 Hypotheses.............................................................................................................................4
Hypothesis 1............................................................................................................................4
Hypothesis 2............................................................................................................................4
Hypothesis 3............................................................................................................................4
Hypothesis 4............................................................................................................................4
3. Estimation Result.........................................................................................................................5
3.1 Descriptive statistics..............................................................................................................5
3.2 Correlation coefficient...........................................................................................................6
3.3 Regression analysis................................................................................................................7
3.4 Multicollinearity....................................................................................................................8
4. Conclusion...................................................................................................................................9
5. References..................................................................................................................................10

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1. Introduction
1.1 Background of the study
Unemployment refers to a state of joblessness in an economy where people though is
willing to work but are unable to find any suitable job. People remain unemployed for various
reasons. Based on different causes of unemployment, unemployment is broadly classified into
three groups – structural unemployment, frictional unemployment and cyclical unemployment
(Goodwin et al. 2015). Persistently higher unemployment rate hampers productivity and
economic growth. Various factors influence rate of unemployment in an economy. When an
economy accounts a steady economic growth for a considerably long period, productivity
increases. This affects labor demand and unemployment in the economy. Inflow of foreign
capital is helpful in expansion of productivity if used effectively. This in turn affects
unemployment rate. Phillips relation explains the relation between unemployment and inflation
(Mitchell 2019). Another factor that can affect unemployment rate in the economy is the export
of goods or services.
1.2 Problem statement
Unemployment is considered as one significant problem of an economy. The research
paper addresses unemployment problem in Japan considering some factors likely to have a
potential impact on unemployment. The likely factors affecting unemployment include GDP
growth, inflation, FDI and export. The objective is to find factors significantly influencing
unemployment rate of Japan.
1.3 Research aim
The paper aims to evaluate relation between rate of unemployment rate and GDP growth,
inflation, export and FDI.
1.4 Data source
All the data relevant for the study has been collected from World Bank data dictionary.
1.5 Research question
The specific research questions that the study addresses are as follows
 How GDP growth in Japan influence unemployment rate of the economy?
 How flow of FDI in Japan influence unemployment rate of the economy?
 How inflation rate in Japan influence unemployment rate of the economy?
 How export in Japan influence unemployment rate of the economy?
2. Literature Review
Different studies have been conducted to determine significant factors affecting
unemployment rate of an economy. The past studies give useful implications for the current
study by indicating proposed relationship between unemployment rate and the targeted variables.
2.1 Relation between unemployment and GDP growth
Okun’s law indicates the theoretical relation between unemployment and economic
growth of United State. The law states that with a decline in unemployment by 1 percent, GDP

3APPLIED ECONOMETRICS
growth increase by 3 percent. Various research papers examined causality between the rate of
unemployment and economic growth of a nation. A research study conducted in 2013 computed
the Okun’s coefficient and examined validity of Okun’s proposition in Nigeria using annual time
series data for the period ranged from 1980 to 2008. In order to examine the relation between
unemployment and economic growth they employed statistical techniques of OLS regression and
Engel Granger causality test (Schubert and Kroll 2016). The empirical evidences of this paper
found a positive regression coefficient meaning that for Nigeria Okun’s law is not applicable.
The paper therefore recommended that policy makers should design policies that can address
structural reforms and associated changes in the labor market. In a paper published in 2012, the
authors tested Okun’ law using time series data of United States and other advanced countries.
The paper concluded that for most countries Okun’s law holds a strong and stable relation
(Lewis et al. 2019). The relation even did not even change in times of great recession.
2.2 Relation between unemployment and FDI
Foreign Direct Investment (FDI) refers to the investments that individual or firm of one
country makes into the business located in another country. In general, FDI is expected to have a
positive impact on the economy contributing to economic prosperity and a lowers
unemployment. Both inward foreign direct investment and outward foreign direct investment
play an important role in economic development of a nation (Irpan et al. 2016). Investment in
projects funded by foreign investors increases demand for skilled and unskilled labors. Foreign
investment thus likely to lower unemployment rate in the economy. Foreign direct investments
that is flowed outward also uses many labors, both domestic and foreign workers for carrying out
production to be exported (Iamsiraroj and Ulubaşoglu 2015). Large-scale foreign direct
investment helps to produce more jobs and improves the state of gross domestic product. GDP is
a representative measure of income of a nation. As income grows due to FDI, unemployment
decrease and vice-versa. A study conducted on unemployment rate in Malaysia found that FDI
plays a supportive role in lowering unemployment rate of the nation (Rahman 2015). Between
1982 and 1991, unemployment rate in Malaysia reached to a high level of 7.5 percent. Rapid
inward foreign investment during this time lowered the unemployment rate indicating a positive
is significant influence of FDI on unemployment (Agrawal 2015).
2.3 Relation between unemployment and export
Exports refer to the goods and services that are first produced in a country and then are
sold to overseas market. Export activity of a nation is inspired by excess supply and excess
demand of a nation with other country (Uribe and Schmitt-Grohe 2017). Expansion of a
country’s export has an effect on state of unemployment in the economy. Research conducted
using data of Malaysia found that unemployment stated an asymmetric integration exists
between the dynamics of unemployment and trade balance in Malaysia. The results found an
inverse relation between trade balance and unemployment. A subsequent paper developed in
2014 concluded that unemployment has a positive and negative influence on the unemployment
rate. Some paper contradicted the findings and concluded that there is no direct impact of trade
balance on unemployment rate of the economy (Alamro 2017). One paper in this field stated that
export of manufacturing has additional effect in terms of a greater employment absorption both
directly and indirectly.

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2.4 Relation between unemployment and inflation
Stability in the domestic price level along with an almost full employment is one primary
macroeconomic goal. The formal relation between inflation and unemployment was first
modelled in the theory of Phillips curve developed by A.W. Phillips in the year 1958. The
Phillip’s theory suggests that there is a trade-off between unemployment and inflation rate of the
economy (Argy and Nevile 2016). That meaning that high inflation rate exits with low
unemployment rate and vice-versa. Significant studies have been conducted to test the Phillip’s
hypothesis. On study found a negative Philip’s relation for South Asian Association of Regional
Cooperation (SAARC) (Bhattarai 2016). This implies, in these Asian countries, unemployment
and inflation move in the opposite direction. One of these studies conclude that during economic
recession, unemployment and inflation move in the conflicting direction. In time of economic
prosperity, these two indicators move in the same direction. For Russia, study also found a
negative significant relation between unemployment and inflation.
2.5 Hypotheses
Hypothesis 1
Null hypothesis (H10): There is no statistically significant relation between GDP growth and
unemployment rate in Japan.
Alternative hypothesis (H11): There exists a statistically significant relation between GDP
growth and unemployment rate in Japan.
Hypothesis 2
Null hypothesis (H20): There is no statistically significant relation between inflation and
unemployment rate in Japan.
Alternative hypothesis (H21): There exists a statistically significant relation between inflation
and unemployment rate in Japan.
Hypothesis 3
Null hypothesis (H30): There is no statistically significant relation between FDI and
unemployment rate in Japan.
Alternative hypothesis (H31): There exists a statistically significant relation between FDI and
unemployment rate in Japan.
Hypothesis 4
Null hypothesis (H40): There is no statistically significant relation between export and
unemployment rate in Japan.
Alternative hypothesis (H41): There exists a statistically significant relation between export and
unemployment rate in Japan.

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3. Estimation Result
3.1 Descriptive statistics
The descriptive statistic of the variables indicates the overall summary statistics, which
include different measures central tendency, dispersion and others. This gives an idea regarding
the average trend, volatility, range and nature of the distribution.
Table 1: Summary statistics of unemployment, GDP growth, inflation, FDI and export
EXPORT FDI
GDP_GROWT
H INFLATION
UNEMPLOYME
NT
Mean 12.66907 0.161140 1.468368 0.523804 3.760700
Median 11.32876 0.114637 1.457548 0.192978 3.950000
Maximum 17.65350 0.794528 6.785020 3.251438 5.400000
Minimum 8.971797 -0.052908 -5.416413 -1.352837 2.100000
Std. Dev. 3.147877 0.192973 2.236099 1.192141 1.026603
Skewness 0.407217 1.462301 -0.366553 0.822971 -0.129888
Kurtosis 1.584968 5.098250 5.027031 2.895616 1.833011
Jarque-Bera 3.332024 16.19494 5.807875 3.400025 1.786684
Probability 0.188999 0.000304 0.054807 0.182681 0.409286
Sum 380.0722 4.834213 44.05105 15.71412 112.8210
Sum Sq. Dev. 287.3647 1.079918 145.0040 41.21482 30.56351
Observations 30 30 30 30 30
The descriptive statistics of the obtained data series show that the average percentage
share of export in Japan’s GDP is 12.7%. That on an average export constituted almost 13
percent of national GDP in the last thirty years indicating importance of trade in Japan’s
economy. The standard deviation of share of export is 3.14. As the standard deviation is smaller
than average share, this indicates stability in the series. The highest and the lowest share of
export are respectively 17.65 percent and 8.97 percent recorded in the year 2017 and 1995
respectively.
So far as the share of FDI is concerned the summary statistics reveals that the average
percentage share of export in Japan’s GDP is only 0.16 percent. That is on an average foreign
investment accounted only 0.16 percent of national GDP in the last thirty years indicating less
reliance on foreign funds in Japan’s economy. The standard deviation of share of export is 0.19.
As the standard deviation exceeds the average share, this indicates foreign investment largely
volatile in Japan. The highest and the lowest share of FDI are respectively 0.79 percent recorded
in 2016 and -0.05 percent recorded in the year 2006.
For the series of GDP growth rate, the average growth rate for the economy is obtained as
1.47 percent. That is on an average the economy grew at a rate of 1.47 percent. The standard
deviation of share of export is 2.23, which is larger than the mean growth rate. As the standard
deviation is greater than average growth, this indicates the economic growth in Japan in the last
thirty years followed a volatile trend. The highest and the lowest growth are respectively 6.79
percent and -5.42 percent recorded in the year 1988 and 2009 respectively.

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The average inflation rate in Japan is 0.52 percent. The average inflation rate implies
price level in the economy increases at an average rate of 0.52 percent. The standard deviation of
inflation rate is 1.19. As the standard deviation exceeds the average share, this indicates foreign
investment largely volatile in Japan. The maximum and minimum rate of inflation are
respectively 3.25 percent and -1.35 percent.
The average unemployment rate in Japan is 3.76 percent. The average inflation rate
implies unemployment in the economy increases at an average rate of 3.76 percent. The standard
deviation of inflation rate is 2.10. As the standard deviation is smaller than average
unemployment rate, this indicates stability in the unemployment series. The highest and the
lowest share of export are respectively 5.40 percent and 2.10 percent respectively recorded
during the period 1991-92 and the period 2009-2010 respectively.
3.2 Correlation coefficient
Analysis of correlation coefficient helps to find out degree of association between the
variables taken into consideration (Cox 2018). High value of correlation coefficient indicates a
strong correlation while a smaller value indicates weak association.
Table 2: Correlation coefficient between unemployment, GDP growth, inflation, FDI and
export
Covariance Analysis: Ordinary
Date: 06/04/19 Time: 10:55
Sample: 1988 2017
Included observations: 30
Correlation
Probability EXPORT FDI
GDP_GROWT
H INFLATION
UNEMPLOYME
NT
EXPORT 1.000000
-----
FDI 0.566103 1.000000
0.0011 -----
GDP_GROWTH -0.180494 -0.304615 1.000000
0.3398 0.1017 -----
INFLATION -0.099326 -0.152012 0.324785 1.000000
0.6015 0.4226 0.0799 -----
UNEMPLOYMENT 0.226047 0.185005 -0.430701 -0.776402 1.000000
0.2297 0.3277 0.0175 0.0000 -----
The above table of correlation coefficient presents association between unemployment
rate and GDP growth, inflation, export and FDI. The coefficient of correlation for unemployment
rate and export share is 0.22. The positive coefficient indicates increase in share of export
increases unemployment. Therefore, expansion of export may not be a good thing for the
economy. Similar is the case for share of FDI in GDP with the value of correlation coefficient
being 0.19. Unemployment rate is negatively associated with GDP growth and inflation rate with

7APPLIED ECONOMETRICS
respective values of correlation coefficient being -0.43 and -0.78. The correlation analysis thus
suggests unemployment has the strongest inverse association with inflation rate.
3.3 Regression analysis
The regression analysis finally helps to establish a statistically significant relation
between dependent and independent variables. In the unemployment model, the dependent
variable is unemployment rate and independent variables are GDP growth, inflation, FDI and
Export.
The regression model to be estimated is
Unemploymentt= β0 +β1 Growtht +β2 Inf t + β3 FDIt + β4 expt +εt
Growth: GDP growth
Inf: Inflation rate
FDI: Percentage of FDI in GDP
Exp: Percentage of export in GDP.
Table 3: Regression of unemployment on GDP growth, inflation, unemployment and
export
Dependent Variable: UNEMPLOYMENT
Method: Least Squares
Date: 06/04/19 Time: 11:01
Sample: 1988 2017
Included observations: 30
Variable Coefficient Std. Error t-Statistic Prob.
C 3.603043 0.556094 6.479193 0.0000
GDP_GROWTH -0.088925 0.059137 -1.503712 0.1452
INFLATION -0.610169 0.106902 -5.707736 0.0000
FDI -0.391746 0.781751 -0.501113 0.6207
EXPORT 0.052961 0.046372 1.142095 0.2642
R-squared 0.656635 Mean dependent var 3.760700
Adjusted R-squared 0.601696 S.D. dependent var 1.026603
S.E. of regression 0.647903 Akaike info criterion 2.120859
Sum squared resid 10.49445 Schwarz criterion 2.354392
Log likelihood -26.81289 Hannan-Quinn criter. 2.195568
F-statistic 11.95219 Durbin-Watson stat 0.870294
Prob(F-statistic) 0.000014
Depending on the regression result, the estimated model is obtained as
^Unemploymentt=¿3.60−0.09 Growtht −0.61 Inf t −0.39 FDIt +0.05 expt ¿
Coefficient Interpretation

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-0.09Growtht If growth increase by 1%, then unemployment decreases by 0.09% in Japan
-0.61Inft If inflation in Japan increases by 1%, then unemployment falls by 0.61%
-0.39FDIt If share of FDI in GDP increases by 1%, then unemployment in Japan falls by -
0.39%
0.05Expt If share of export in GDP increases by 1% percent in Japan, then unemployment
increases by 0.05%.
From the model, the value of R square is obtained as 0.60. That means the four
independent variables account 60 percent variation in unemployment rate. Rest of the variations
are explained by other factors. The p value for F statistics is 0.0000. The significant F value is
less than level of significance of 0.05. This implies the model is an overall significant model. Of
all the independent variables considered in the model, except export all show a positive relation
with unemployment. That means an increase in GDP growth, inflation and FDI contribute to a
decline in unemployment rate (Fox 2015). While increase in export aggravates the problem of
unemployment.
The effective influence of these factors on unemployment rate of Japan depend on
statistical significance of the coefficient. For GDP growth the obtained p value is 0.1452. The p
value is greater than significance value of 0.05 meaning acceptance of null hypothesis of no
significant relation between GDP growth and unemployment rate of Japan. In case of inflation,
the p value is 0.0000. The p value is less than significance value of 0.05 meaning rejection of
null hypothesis of no significant relation between inflation and unemployment rate of Japan. For
FDI, the obtained p value is 0.6207. The p value is larger compared to 5 percent significance
level meaning acceptance of null hypothesis of no significant relation between FDI and
unemployment rate of Japan (Schroeder, Sjoquist and Stephan 2016). Finally, for export
obtained p value is 0.2642. The p value is greater than significance value of 0.05 meaning
acceptance of null hypothesis of no significant relation between GDP growth and unemployment
rate of Japan.
3.4 Multicollinearity
The problem of Multicollinearity arises following a strong interrelation between the
independent variables taken into consideration. Perfect multicollinearity exists in the presence of
strong correlation between two or more independent variables. The presence of perfect
multicollinearity make the OLS estimates insignificant. On the other hand, if the relation
between two variables are probabilistic then it said to have imperfect multicollinearity. Apart
from correlation coefficient, one way to detect multicollinearity is to estimate Variance Inflation
factor. Multicollinearity is a severe problem if VIF is greater than 5.
VIF= 1
1−R2

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Table 4: Variance Inflation Factor
Variance Inflation Factors
Date: 06/10/19 Time: 23:58
Sample: 1988 2017
Included observations: 30
Coefficient Uncentered Centered
Variable Variance VIF VIF
C 0.309241 22.10033 NA
GDP_GROWTH 0.003497 1.746900 1.208026
INFLATION 0.011428 1.346120 1.122035
FDI 0.611135 2.706294 1.572203
EXPORT 0.002150 26.13810 1.472049
In examining multicollinearity, focus should be given on Centered VIF. As shown from
the above table, for neither of the variable VIF is greater than 5. This indicates multicollinearity
is not a severe problem for the model.
4. Conclusion
The paper aims to analyze how different macroeconomic variables affect unemployment
rate Japan. The result finds that inflation, GDP growth and FDI adversely affect rate of
unemployment in Japan. That is with increases in any of these factors unemployment decreases.
The finding however is different for export. For export share, unemployment moves in the same
direction of export contradicting most of the past studies. Inflation in an economy measure
movement in the average price level. A higher price level indicates means higher profitability.
This encourages production, increases labor demand and reduces unemployment rate. As
economic growth increases productive activity increases which in turn reduces unemployment.
similar is the impact of Foreign Direct Investment on Unemployment. So far as export is
concerned, an increase in export boosts production of a nation by adding external demand along
with domestic demand. This likely to lower unemployment rate. However, for Japan the impact
of export is opposite. This is due to tendency of Japan to export capital intensive good.
The main limitation of the study is that it considers only growth, inflation, FDI and
export as an influencing factor of unemployment. It excludes other important variables like
health, education and others that might influence unemployment in Japan. Another limitation of
the paper is that of the four considered factors only inflation turns out to be statistically
significant and hence, the paper has only limited policy implication.

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5. References
Agrawal, G., 2015. Foreign direct investment and economic growth in BRICS economies: A
panel data analysis. Journal of Economics, Business and Management, 3(4), pp.421-424.
Alamro, H., 2017. The Effect of Trade Liberalization on Economic Growth, Unemployment and
Productivity: The Case of Jordan. International Review of Management and Marketing, 7(5),
pp.131-139.
Argy, V.E. and Nevile, J., 2016. Inflation and Unemployment: Theory, Experience and Policy
Making. Routledge.
Bhattarai, K., 2016. Unemployment–inflation trade-offs in OECD countries. Economic
modelling, 58, pp.93-103.
Cox, D.R., 2018. Applied statistics-principles and examples. Routledge.
Fox, J., 2015. Applied regression analysis and generalized linear models. Sage Publications.
Goodwin, N., Harris, J.M., Nelson, J.A., Roach, B. and Torras, M., 2015. Macroeconomics in
context. Routledge.
Iamsiraroj, S. and Ulubaşoglu, M.A., 2015. Foreign direct investment and economic growth: A
real relationship or wishful thinking?. Economic Modelling, 51, pp.200-213.
Irpan, H.M., Saad, R.M., Nor, A.H.S.M., Noor, A.H.M. and Ibrahim, N., 2016, April. Impact of
foreign direct investment on the unemployment rate in Malaysia. In Journal of Physics:
Conference Series (Vol. 710, No. 1, p. 012028). IOP Publishing.
Lewis, B., Veronica, C.M., Francis, N. and Isaac, A., 2019. Effects of Gross Domestic Product
and Inflation Rate on Unemployment Rate in Ghana: Comparative Analysis of Multiple
Regression and Covariance Matrix Models. American Journal of Applied Mathematics, 7(1),
pp.5-12.
Mitchell, W., 2019. Macroeconomics. Macmillan International Higher Education.
Rahman, A., 2015. Impact of foreign direct investment on economic growth: Empirical evidence
from Bangladesh. International Journal of Economics and Finance, 7(2), pp.178-185.
Schroeder, L.D., Sjoquist, D.L. and Stephan, P.E., 2016. Understanding regression analysis: An
introductory guide (Vol. 57). Sage Publications.
Schubert, T. and Kroll, H., 2016. Universities’ effects on regional GDP and unemployment: The
case of G ermany. Papers in Regional Science, 95(3), pp.467-489.
Uribe, M. and Schmitt-Grohe, S., 2017. Open economy macroeconomics. Princeton University
Press.