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An examination of Okun's law: evidence from regionalareas in GreeceNicholas Apergis a; Anthony Rezitis ba Department of International Economics and Political Sciences, University ofMacedonia, Thessaloniki, Greece.b Department of Economics, University of Ioannina, Ioannina, Greece.

Online Publication Date: 10 January 2003

To cite this Article: Apergis, Nicholas and Rezitis, Anthony (2003) 'An examinationof Okun's law: evidence from regional areas in Greece', Applied Economics, 35:10,1147 1151

To link to this article: DOI: 10.1080/0003684032000066787URL: http://dx.doi.org/10.1080/0003684032000066787

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Electronic copy available at: http://ssrn.com/abstract=1150126

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An examination of Okuns law:

evidence from regional areas in Greece

NICHOLAS APERGIS* and ANTHONY REZITIS#

*Department of International Economics and Political Sciences,University of Macedonia, Thessaloniki, Greece and#Department of Economics, University of Ioannina, Ioannina, Greece

This paper estimates Okuns coefficient for certain regional areas in Greece over theperiod 19601997. Through the HodrickPrescott filtering and the band-passfiltering the empirical analysis shows that that the coefficients do not exhibitsubstantial interregional differences, except for the cases of Epirus and NorthAegean Islands. In these two cases, the estimates are larger than the regional averageunder both detrending methodologies. The empirical findings also show that Okunsrelationship undergoes a structural change in 1981. After this break, unemploymentbecomes less responsive to output changes in all regional areas.

I . INTRODUCTION

Okuns famous law (Okun, 1962) stated that excesscapacity or a lack of demand is the major source for thepresence of unemployment. More specifically, the lawpostulated a simple relationship between unemploymentand output growth. According to this, an increase of 1% inthe unemployment rate leads to a fall of about 3% in thegrowth of real GNP. The law has been frequently used inconjunction with the Phillips curve for economists as wellas policy makers to understand the implications of certaineconomic policy measures for labour as well as commoditymarkets (Knoester, 1986).The statement of the Okuns law yields:

Y yT u uT 1

where y represents output, expressed in natural logarithms,u is the unemployment rate, expressed in percentage terms,and the exponent T in the variable refers to correspond-ing equilibrium values, i.e. potential output and naturalunemployment, respectively. The two dierences inEquation 1 dene the output and the unemployment gap,respectively. Finally, is the Okun coecient.Relevant studies have investigated the properties of

Okuns law for certain economies (Motley, 1984;Knoester, 1986; Holloway, 1989; Watts and Mitchell,1991; Prachowny, 1993; Moosa, 1997). While the majority

of these studies investigated the validity of the law for theUSA, the relationship has also been examined for othercountries as well (Knoester, 1986; Kaufman, 1988; Moosa,1997). Knoester (1986) reported that the law was notenough to explain the high unemployment rates for Europe,especially after the 1970s. Prachowny (1993) and Attfieldand Silverstone (1995) provided evidence that a 1%reduction in unemployment leads to only a 2/3% increasein output. Attfield and Silverstone (1995) estimated thecoefficient of Okuns law for the UK by applying recentdevelopments in time series analysis, i.e. cointegrationtechniques.This study attempts to test Okuns law using data for

Greeces regional economies as they are defined by theNational Statistical Service over the period 19601997in order to get evidence on regional differences in theresponsiveness of labour markets to output changes. Theresults will motivate policy makers to adopt strategiesthat will rescue the economy from the problem ofunemployment.The methodology used to decompose output and

unemployment from their trend, i.e. to get the output andthe unemployment gap, is that of the HodrickPrescottfilter (Hodrick and Prescott, 1997) and the band-pass filtersuggested by Baxter and King (1995). Although the formermethodology has frequently been used to obtain the cyclicalcomponent of a series, the latter exhibits the advantagethat it filters out both the high frequency fluctuations,

Applied Economics, 2003, 35, 11471151

Applied Economics ISSN 00036846 print/ISSN 14664283 online 2003 Taylor & Francis Ltd 1147http://www.tandf.co.uk/journals

DOI: 10.1080/0003684032000066787

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e.g. irregular components, and the low frequency fluctua-tions, e.g. autocorellation. These high and low frequencyfluctuations are not eliminated after taking the firstdifferences, and applying the HodrickPrescott filter,respectively, of the relevant series.The paper is organized as follows. Section II presents a

brief economic historical background for the economy ofGreece related to Okuns relationship, while Section IIIprovides the empirical analysis and discusses certain policyimplications related to the unemploymentgrowth issue.Finally, Section IV provides some concluding remarks.

II . A BRIEF HISTORY BACKGROUND

In the 1960s and 1970s, the Greek economy was character-ized by low unemployment rates. By contrast, beginning in1981, the economy experienced a disappointing growthperformance that led to a substantial increase in unemploy-ment. More specifically, unemployment jumped from 2.7%in 1980 to 8.1% by 1984. Since then, unemployment hascontinued to persist at high levels and in 2000 reached arecord high at 11.3%, despite the economy havingexperienced high growth rates since 1993. In the light ofGreeces participation in the European Monetary Union(EMU) from 1 January 2001, Greek policy makers had topursue economic policies characterized by conflicting objec-tives. In particular, the desirability of the Governmentsobjective of achieving a very low inflation rate was inconflict with the objective of maintaining economic growthat sufficiently high rates to reduce unemployment.It is also highly likely that certain structural changes,

mainly after 1981, tended to have had a strong impact onthe growth rate of potential GNP as well as on thesensitivity of unemployment to current real GNP changes.More specifically:

After 1980 the services sector experienced high growthrates, while the contribution of manufacturing to total

output was signicantly lower. In particular, employ-

ment in the services sector increased by 55%, while its

counterpart in the industrial sector fell by 11.6%. Since

the demand for services diers from the demand for

industrial output in terms of sensitivity to economic

uctuations, it is highly likely that Okuns coecient

must have changed over the post-1980 period. After 1980, the productivity of labour critically sloweddown and it remained stagnant over the entire period. In

particular, over the period 19611980 the hourly labour

productivity increased, on average, by 5% on an annual

basis. By contrast, over the period 19811997 it

experienced only a 0.6% increase. These facts suggest a

changed relationship between unemployment and

growth, i.e. a dierent Okun coecient.

Finally, in 1980, percentage unemployment gures werearound 2.8%, while those gures reached 8% in 1988, a

gure which represented the average OECD and

European Union (EU) unemployment rates. Today,

unemployment in Greece lies at a gure above 11%

(11.3% at the end of 2000). After 1980, the legislation

that protects massive layos was critically improved in

favour of the workers. Moreover, the most painful

characteristic of unemployment gures in Greece is that

a substantial portion of total unemployment is char-

acterized as long-term unemployment. Over the period

19811988 the percentage of those who were unem-

ployed for more than 12 months rose from 21% to

42.2%. Today, over 50% of unemployed can be

characterized as long-term unemployed. Meghir et al.

(1989) provided empirical support to the prolonged

duration of unemployment in Greece. The reported data

on unemployment in Greece suggest the presence of

persistence and hysteresis phenomena. Elmeskov and

MacFarlan (1993) and Apergis (1997) have provided

evidence in favour of such phenomena in Greece. The

observed hysteresis phenomena in the labour market

prevent employment from falling during recession times;

however, in the case of boom conditions, corporations

are reluctant to hire unemployed individuals, resulting in

a slow decrease in unemployment. Thus, the presence of

hysteresis phenomena is expected to have changed

Okuns coecient over the post-1980 period.

To date there has been no specic study that hasinvestigated relevant issues for specic regions in Greece.Only the study by Paraskevaides (1993) has demonstratedthat the stagation conditions that Greece has experiencedover the last twenty years have hurt more painfully, interms of higher unemployment, the regions of Epirus, WestMacedonia, and the Islands of North Aegean Sea. Theincome of these regions originated primarily through theprimary sector of production (over 80%). In this manner, itis expected that the changes mentioned above, whichoccurred in the production side of the Greek economy after1981, are expected to have dramatically changed, appar-ently for the worse, the employment conditions in thoseregions.

III . EMPIRICAL ANALYSIS

Data

The empirical analysis is carried out using annual data onoutput measured by real GDP (Y) at 1990 prices and theunemployment rate (U) covering the period 19601997 foreight regional areas of Greece. These regions are definedas: East Macedonia, Central and West Macedonia, Attiki

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plus the Rest of Sterea Hellas, Epirus, Thessalia, WestHellas plus The Ioanian Islands plus Pelloponisos, TheIslands of the North Aegean Sea, and The Islands of theSouth Aegean Sea plus Crete. Data were obtained fromthe Statistical Service of Greece. For the empirical purposesof this study, gaps in output and unemployment data hadto be estimated. These gaps are viewed as the cyclicalcomponent of the output and unemployment series. As wasmentioned in the introductory section, two alternativemethodologies were employed to estimate the cyclicalcomponents of the two series under investigation, i.e. theHodrickPrescott filter decomposition and the band-passdecomposition. For the empirical purposes of the paper,the band-pass analysis follows the suggestions of Baxterand King (1995), who recommend for annual data a high-frequency cut-off point of 2 years and a low-frequency cut-off point of 8 years. The empirical analysis was carried outwith the assistance of RATS 4.2 and MATLAB software.

Regional estimates of Okuns coefficient

Table 1 reports estimates of Okuns coefficients for theregional data in Greece under the two alternativemethodologies and for the entire period under study. Theresults show that the Okuns coefficients for all the regionsunder study are statistically significant at 5% across thedetrending methodology followed. Serial correlation (LM)tests, performed for each equation, show the absence ofany serial correlation problems. Likelihood Ratio tests,reported in Table 2, indicate that the coefficients do notexhibit substantial interregional differences, except for thecases of Epirus and the North Aegean Islands, where theyare larger than the regional average under both detrendingmethodologies.Furthermore, ZivotAndrews (1992) endogenous break

unit root tests (available upon request) performed on theoriginal income and unemployment data indicated thepresence of a break in 1981. Based on the endogenousbreak tests, the filtered series were re-estimated for each ofthe separate subperiods under study. Table 3 presentsestimates of Okuns coefficients for the regional data inGreece, but this time the sample has been split into twoalternative time periods, prior and after 1981. The resultspoint out that the estimates of Okuns coefficients differover the two sample periods. In particular, all regionalcoefficients experienced a decrease under both alternativeestimation methodologies. In order to test the statisticalsignificance of the equality of coefficients across theestimated Okun equations we proceed with the followinganalysis:Let:

y yT t 0 1tu uT t ut 2 y yT t 00 11u uT t ut 3

be the two regressions corresponding to the pre- and post-1981 period. Dene a dummy variable Dt, which takesthe value 0 over the pre-1981 period and 1 otherwise.Introducing the dummy variable into Equation 2 yields amodied regression of the form:

y yT t 0 1u uT t Dtu uT t vt 4

Over the pre-1981 period Equation 4 turns out to be:

y yT t 0 1u uT t vt 5

while over the post-1981 period Equation 4 yields:

y yT t 0 1 u uT t vt 6

Table 1. Estimates of Okuns coefficient for the Greek regions from 1960

to 1997

RegionsHodrickPrecottfilter

Band-passfilter

East Macedonia 1.15 1.22(2.54)* (3.01)*

LM 3.79[0.43] 4.08[0.38]

Central and West Macedonia 1.54 1.66(2.88)* (2.97)*

LM 4.29[0.23] 4.17[0.27]

Thessalia 1.63 1.87(2.87)* (4.11)*

LM 3.13[0.37] 3.48[0.34]

Epirus 2.97 3.19(3.24)* (2.87)*

LM 3.21[0.36] 2.78[0.52]

Attiki and Sterea Hellas 1.17 1.42(3.36)* (3.13)*

LM 4.53[0.23] 3.39[0.36]

West Hellas and IoanianIslands and Pelloponisos 1.56 1.77

(3.61)* (4.38)*LM 4.22[0.24] 4.51[0.19]

North Aegean Islands 3.56 3.69(3.14)* (4.09)*

LM 5.18[0.17] 4.64[0.26]

South Aegean Islands and Crete 1.35 1.44(4.51)* (3.76)*

LM 2.96[0.41] 2.55[0.59]

Notes: Figures in parentheses denote t-statistics. For the estimation of

regional average the ratio of income in the region to total income was

used as weighting. LM is a serial correlation test. * Denotes statistically

significant at 5%.

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The testable hypothesis is H0: 0 against H1: 6 0. Theresults reported in Table 4 demonstrate that in all regionsthe gamma () coecient is shown to be dierent fromzero, implying that Okuns coecients have changed(declined) over the post-1981 period for reasons mentionedin Section II.

IV. CONCLUDING REMARKS ANDPOLICY IMPLICATIONS

The goal of this paper has been to provide estimates forOkuns relationship for regional areas in Greece over theperiod 19601997. By making use of two alternativedetrending techniques, namely, the HodrickPrescottfilter and the band-pass filter, the results showed that thecoefficients did not exhibit substantial interregional differ-ences, except for the cases of Epirus and North AegeanIslands. In these two cases, the estimates were larger thanthe regional average under both detrending methodologies.Moreover, the empirical findings showed that Okuns

relationship underwent a structural change in 1981. Afterthis year, unemployment was shown to be more responsiveto output changes, i.e. economic growth. These findings

Table 2. Likelihood ratio tests (testing restrictions across Okun equations)

a1 a2 a3 a4 a5 a6 a7

a1 0.72 0.03 4.89 0.30 1.58 3.93 2.31[0.39] 0.87] [0.02] [0.58] [0.21] [0.03] [0.13]

a2 2.11 5.17 1.87 1.96 17.26 0.05[0.17] [0.00] [0.26] [0.28] [0.00] [0.83]

a3 7.15 0.62 1.79 6.44 2.03[0.00] [0.43] [0.18] [0.00] [0.19]

a4 4.92 4.15 5.46 6.26[0.03] [0.04] [0.01] [0.00]

a5 0.85 0.02 2.16[0.36] [0.89] [0.15]

a6 7.97 0.78[0.00] [0.38]

a7 4.32[0.04]

RATIO 7.73[0.005] 8.94[0.002]

Notes: Figures denote Likelihood Ratio tests. The coefficients a1, a2, a3,

a4, a5, a6, and a7 correspond to the combination between East Macedonia

and Central and West Macedonia, between East Macedonia and

Thessalia, and so on. RATIO is a Likelihood Ratio test (under the two

alternative detrending methods) that inspects the restriction that the

estimated Okun coefficients are all equal across equations. Figures in

parentheses denote p-values.

Table 3. Estimates of Okuns coefficient for the Greek regions from 1960 to

1980 and from 1981 to 1997

Regions HodrickPrecott filter Band-pass filter

East Macedonia

19601980 1.03 1.14

(3.22)* (2.87)*

LM 2.79[0.37] 2.55[0.43]

19811997 0.97 1.01

(2.69)* (3.44)*

LM 2.68[0.39] 2.42[0.47]

Central and West Macedonia

19601980 1.29 1.50

(3.26)* (4.05)*

LM 3.09[0.31] 2.86[0.35]

19811997 0.88 1.29

(3.47)* (4.71)*

LM 2.91[0.34] 2.18[0.52]

Thessalia

19601980 1.41 1.55

(2.66)* (3.91)*

LM 4.64[0.14] 3.95[0.20]

19811997 1.12 1.28

(2.81)* (3.55)*

LM 2.33[0.56] 2.13[0.59]

Epirus

19601980 2.31 2.44

(3.12)* (3.68)*

LM 3.69[0.25] 3.44[0.29]

19811997 2.16 2.38

(3.42)* (3.17)*

LM 4.21[0.19] 3.73[0.23]

Attiki and Sterea Hellas

19601980 1.06 1.33

(3.65)* (3.79)*

LM 3.65[0.26] 3.38[0.35]

19811997 0.72 0.97

(4.09)* (3.28)*

LM 2.08[0.62] 1.76[0.68]

West Hellas and Ioanian Islands and Pelloponisos

19601980 1.14 1.36

(3.12)* (4.79)*

LM 3.49[0.34] 3.27[0.39]

19811997 0.84 1.11

(2.48)* (3.73)*

LM 3.11[0.40] 2.71[0.45]

North Aegean Islands

19601980 2.79 2.81

(3.41)* (4.52)*

LM 2.65[0.38] 2.25[0.43]

19811997 2.56 2.58

(3.44)* (4.59)*

LM 2.31[0.40] 1.89[0.57]

South Aegean Islands and Crete

19601980 1.04 1.17

(3.67)* (3.91)*

LM 3.04[0.34] 2.58[0.46]

19811997 0.78 0.89

(2.77)* (3.44)*

LM 2.41[0.49] 2.07[0.53]

Notes: As for Table 1.

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have some serious policy implications regarding thestrategy against unemployment the policy makers shouldfollow. More specifically, policy makers must place moreemphasis on deregulating certain sectors in the economy,particularly, the labour market. This will lead to higherlabour productivity and competition, which in turn, willincrease the productivity of the overall economy anddecrease unemployment in all regions, especially in thosethat need it most, e.g. Epirus and North Aegean Islands.

REFERENCES

Apergis, N. (1997) Hysteresis in unemployment and businesscycles: the case of Greece. Working Paper, University ofMacedonia.

Attfield, C. L. F. and Silverstone, B. (1998) Okuns law,cointegration and gap variables, Journal of Macroeconomics,20, 62537.

Baxter, M. and King, R. G. (1995) Measuring business cycles:approximate band-pass filters for economic time series.Working Paper 5022, National Bureau of EconomicResearch.

Elmeskov, J. and MacFarlan, M. (1993) Unemployment persis-tence. OECD Economic Studies, 21, 6088.

Hodrick, R. J. and Prescott, E. C. (1997) Postwar US businesscycles: an empirical investigation, Journal of Money, Credit,and Banking, 29, 116.

Holloway, T. M. (1989) An updated look at Okuns law, SocialScience Quarterly, 70, 497504.

Kaufman, R. T. (1988) An international comparison of Okunslaw, Journal of Comparative Economics, 17, 182203.

Knoester, A. (1986) Okuns law revisited, WeltwirtschaftlichesArchiv, 122, 65765.

Meghir, C., Ioannides, Y., and Pissarides, C. (1989) Femaleparticipation and male unemployment duration in Greece,European Economic Review, 33, 395406.

Moosa, I. A. (1997) A cross-country comparison of Okunscoefficient, Journal of Comparative Economics, 24, 33556.

Motley, B. (1994) How soon will the US reach full employment?an assessment based on Okuns law, Federal Reserve Bank ofSan Francisco Economic Review, 3, 2639.

Okun, A. M. (1962) Potential GNP: its measurement andsignificance, In American Statistical Association.Proceedings of the Business and Economic Statistics Section.

Paraskevaides, P. (1993) Income Inequalities and RegionalDistribution of the Labour Force, Center of Planning andEconomic Research, Athens.

Prachowny, M. F. J. (1993) Okuns law: theoretical foundationsand revised estimates, The Review of Economics andStatistics, 75, 3316.

Watts, M. and Mitchell, W. (1991) Alleged instability of theOkuns law relationship in Australia: an empirical analysis,Applied Economics, 23, 182938.

Zivot, E. and Andrews, D. W. K. (1992) Further evidence on thegreat crash, the oil-price shock, and the unit root hypothesis,Journal of Business and Economic Statistics, 10, 25170.

Table 4. Testing restrictions across Okun equations over the pre- and post-

1981 period

Region t-statistic (of )

East Macedonia 3.76[0.0]Central and West Macedonia 3.49[0.0]Thessalia 4.03[0.0]Epirus 4.56[0.0]Attiki and Sterea Hellas 3.61[0.0]West Hellas and Ioanian Islands and Pelloponisos 3.45[0.0]North Aegean Islands 4.83[0.0]South Aegean Islands and Crete 3.03[0.0]

Notes: Figures in brackets denote p-values.

An examination of Okuns law: evidence from regional areas in Greece 1151