Academic journal article International Advances in Economic Research

A Nonlinear Relationship: Unemployment and Economic Growth Construction Sector in Spain, 1995.1-2012.2

Academic journal article International Advances in Economic Research

A Nonlinear Relationship: Unemployment and Economic Growth Construction Sector in Spain, 1995.1-2012.2

Article excerpt

Published online: 24 October 2014

[C] International Atlantic Economic Society 2014

Abstract A quadratic version of the first-difference Olcun's Law model was estimated for Spain (1995.Q1-2012.Q2). An accelerationist version of Okun's Law was obtained, which allowed us to calculate variable Okun coefficients as well as critical points in the relationship between construction sector growth and the variation in overall unemployment. The optimal economic growth rate was determined to be 7.38 %. By applying principal components, it is demonstrated that this sector led the economic process after 1995.

Keywords Spain * First-difference Okun's Law (accelerationist version) * Variable Okun coefficients * Quadratic function * Unemployment * Construction sector

JEL Classification C52 * E24 * L74

Introduction

The integration of Spain into the Eurozone in 1999 produced, among other things, a low-interest-rate environment that expanded the construction sector and the demand for goods and services through credit. This credit boost allowed an increase in the supply of long-term (20 years or more) mortgages, therefore financial institutions increased credit to the construction sector. This led to a surge in housing prices, which subsequently boosted residential real estate investment and capital inflows from German banks. Consequently, the demand for low-skilled jobs with temporary contracts soared. The unemployment rate, which in previous years had been around 20 %, dropped drastically, but once the economic boom collapsed, the unemployment rate returned to its previous historic levels.

This short boom was accompanied by high and growing budgets and external disequilibria due to the fact that a key export sector was absent. Balassa (1978) (1) and Chow (1987) claim that there is a direct relationship between industrial development and both export booms and economic growth. This line of research is fairly well established and was expanded through the work of Jung and Marshall (1985) for 35 countries, which consistently continued to show that accelerated growth processes have traditionally had a strong link to the external sector.

In Spain, the dramatic drop in unemployment was a consequence of an accelerated but fickle growth process (1997-2006), which was itself propelled by a strong noncommercial goods sector that generated multiple imbalances. (2) This is due to the assumption that this case is paradigmatic in the sense that economic growth enlarged the external sector deficit (current account and foreign debt), which Spain sought to minimize in view of the common currency (Euro). This imbalance, along with the fiscal one, led inevitably to collapse.

Accelerated growth on the part of a particular sector yields a relationship that could hardly be considered nonlinear. While the construction sector created unskilled jobs, the reduction in unemployment increased the labor supply by attracting strong inflows of migrants and young Spaniards that dropped out of school to enter the labor market. Using principal component analysis we are able to demonstrate that the construction sector led the "Spanish economic miracle." (3) Thus, it is ultimately in this sector that we see the rise (1995-2007) and fall (2008 onwards) of the Spanish economy.

In economics, we almost always assume linear relationships among variables. In determining the unemployment rate it is very common to use Olcun's specification (1962). (4) Although Okun's Law has been extensively (empirically) used for different countries, several articles (5) strongly criticize the linearity of the original contribution. Therefore, in this paper, in order to overcome this issue we explore nonlinearities by using a quadratic functional form that allow us to calculate variable Okun coefficients and to find several critical points that are very useful for economic analysis.

By doing this, we arrive at four relevant results: a) the Okun coefficient varies dramatically for the whole period; b) rates of growth of 1. …

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