The role of labor market regulations on the sensitivity of unemployment to economic growth

Abstract

Okun’s law suggests that economic growth and unemployment are negatively correlated–i.e., a 1% increase in GNP is associated with a decrease in the unemployment rate of 0.3 percentage points. However, agreement on the magnitude of this effect, the so-called Okun’s coefficient, is far from consistent. Empirical findings suggest that Okun’s coefficient varies for males and females, across educational attainment levels, between countries with different labor market regulations, and over recession and expansion periods. This paper is among the first attempts to jointly consider the abovementioned aspects of the heterogeneity of Okun’s law. Our empirical examinations are based on data from European Union countries over the 2000–2020 period. With quarterly data, we apply time-series regressions and estimate gender-, age- and educational attainment level-specific Okun’s coefficients for each country. In the second step, we run cross-country regressions to establish whether labor market regulations influence the responsiveness of unemployment to output growth. We use panel specifications and time-varying Okun’s coefficients to check robustness. Our results show that straightening labor market regulation would not significantly reduce the possibilities for growth to reduce unemployment.