Hysteresis in Regional Unemployment Rates in Turkey

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1 Internatonal Journal of Economcs and Fnance; Vol. 4, No. 9; 2012 ISSN X E-ISSN Publshed by Canadan Center of Scence and Educaton Hysteress n Regonal Unemployment Rates n urkey Gray Gozgor Correspondence: Gray Gozgor, Internatonal rade and Busness, Dogus Unversty, Istanbul, Zeamet Street 21 K505 Acbadem Kadkoy urkey. el: /1554. E-mal: ggozgor@dogus.edu.tr Receved: June 26, 2012 Accepted: July 24, 2012 Onlne Publshed: July 31, 2012 do: /jef.v4n9p175 URL: Abstract It s mportant for polcy-makers to understand the nature of unemployment, partcularly n the regonal level. As a developng country, urkey suffers from severe unemployment, as well as major regonal dscrepances, even n the perods of hgh-level economc growth. In ths study, we analyze a possble hysteress effect n regonal unemployment rates n urkey from 2004 to We apply heterogeneous or homogenous Panel-based Unt Root (PUR) tests that they can be arranged n groups by cross-secton ndependence or cross-secton dependence. Results of the PUR tests show that there s no mean-reverson n regonal unemployment rates and natural-rate of unemployment hypothess s strongly rejected. hus, emprcal results provde sgnfcant support for the exstence of the hysteress hypothess n regonal unemployment rates n urkey. Keywords: hysteress, regonal unemployment, panel unt root tests, natural rate of unemployment, cross-secton dependence, urksh economy 1. Introducton here are persstent unemployment rates n many developed countres and emergng economes durng the last decades. hs sght about unemployment rates s cted as evdence n favor of the hysteress hypothess. Generally, unemployment dynamcs can be explaned by two opposte theoretcal vews; namely, the Non-acceleratng Inflaton Rate of Unemployment (NAIRU) hypothess and the hysteress hypothess. (Note 1). In ths context, the Classcal vew descrbes the unemployment fluctuatons as cyclcal devatons from the natural-rate or the NAIRU. However, Keynesan vew defnes the unemployment rate as a hysteretc process and t suggests that temporary shocks on unemployment rate wll have permanent effects. On ths account, frst vew ndcates that unemployment rates should follow a statonary or a mean-revertng process, and the second one denotes that unemployment rates should follow a non-statonary or a unt root process. Fredman (1968) and Phelps (1968) frstly proposed the NAIRU hypothess and they suggested that unemployment rate s a statonary process or a mean-reverson. However, many researchers were skeptcal about the NAIRU hypothess as unemployment rates showed that hgh-level and persstent characterstcs n the 1970 s and n the early 1980 s. So, there was a puzzle that the NAIRU hypothess was not able to explan. he soluton seekng to address the puzzle resulted n the hysteress hypothess. he hysteress hypothess suggests that cyclcal fluctuatons n the labor market can sgnfcantly and permanently affect the unemployment rate, and ths can lead to the long-term persstence. hus, unemployment rates should follow a unt root process. On the bass of ths vew, f unemployment rates are a unt root process, the shocks affectng the seres wll have permanent effects. In other words, shocks wll shft the unemployment equlbrum from one level to another. Blanchard and Summers (1986) were the frst to examne the hysteress hypothess, and they argued that a rase on the unemployment rate n a suffcent length of tme was bound to affect the natural-rate of unemployment, due to the barganng power of nsders. In ths case, the polcy-pont of ths vew can be summarzed as the polcy acton s certanly necessary to turn back frst equlbrum level of the unemployment rate. On the other hand, f unemployment rates are a mean-revertng process, the effect of the shocks wll be transtory. As a result, the necessty for a polcy acton s subordnate, snce the unemployment rate wll naturally return to ts frst equlbrum level. However, t s mportant for polcy-makers to understand the nature of unemployment, partcularly n the regonal level. At ths pont, t can be sad that less number of papers have focused on regonal unemployment rates. Song and Wu (1997, 1998) used the LLC PUR test by Levn et al. (2002), from the 1960 s to 1992Q2 n 48 states of the Unted States (US). he LLC PUR test concluded that the hysteress hypothess s rejected. 175

2 Internatonal Journal of Economcs and Fnance Vol. 4, No. 9; 2012 Leon-Ledesma (2002) used the data from 1985Q1 to 1990Q4 n 51 US states and he concluded that the rejecton of the hysteress hypothess by Im et al. (2003) s the IPS PUR test. On the contrary, Smyth (2003) both used the LLC and the IPS PUR tests from the 1983Q2 to 2002Q1 n states of Australa and he concluded that the hysteress hypothess was vald. Chang et al. (2007) used the LLC, the IPS and aylor and Sarno (1998) s PUR tests from 1993M7 to 2001M9 n 21 regons of awan, and they concluded that the hysteress hypothess was rejected by all PUR tests. Gomes and Da Slva (2009) appled the unt root test by Lee and Strazcch (2003) from 1981M1 to 2002M12 n 6 major Brazlan metropoltan-areas and the result of unt root tests showed that the hysteress hypothess was only rejected n one regon. Lanzafame (2012) recently concluded that the hysteress hypothess was only vald n 1 of 20 regons n Italy. he man objectve of ths paper s to test the possble presence of hysteress n the regonal unemployment rates n urkey. As a developng country, urkey suffers from severe unemployment, as well as major regonal dscrepances, even n the perods of hgh-level economc growth. We suggest that nvestgatng the valdaton of the hysteress hypothess n regonal unemployment s not only crtcal for researchers, but also for the polcy-makers. o our best knowledge, no work has systematcally so far addressed the presence of hysteress effect n the regons of urkey. he only avalable emprcal evdence descrbes the wde regonal unemployment dspartes n urkey from 1980 to 2000 by usng the nonparametrc statstcal technques (Flztekn, 2009). Furthermore, there s also no emprcal result that obtaned from the PUR tests. We apply heterogeneous or homogenous PUR tests that they can be arranged n groups by cross-secton dependence or ndependence. We also know that the classcal unt root tests are characterzed by some power problems n the lterature. So, ths paper contrbutes to the related lterature on the evaluaton for mean-reverson or unt root propertes of the regonal unemployment rates n urkey by usng more powerful PUR tests. In the followng secton, the methodology, data used n ths study, the emprcal fndngs have been defned and elaborated. he fnal secton s the concluson. 2. Data and Methodology In ths secton, we use unemployment rates of 26 regons n urkey for the perod from 2004 to We select ths perod because regonal unemployment rates n urkey only avalable n ths perod. he frequency of data s yearly. Unemployment rates of the regons are defned by the regonal-level, namely, Nomenclature of errtoral Unts for Statstcs (NUS) II. We obtan the data from urksh Statstcal Insttute (SI). (Note 2). he classcal unt root tests, such as Dckey and Fuller (1979) are subject to some crtcsm that s occurred from the low-power of these tests n small samples, n order to defne a unt root process. Consequently, PUR tests have begun to be wdely used n the lterature. In ths study, we employ PUR tests that they can be arranged n groups by cross-secton dependence or ndependence and heterogeneous or homogenous unt roots such that proposed by Maddala and Wu (1999), Bretung (2000), Hadr (2000), Cho (2001), Levn et al. (2002), Im et al. (2003), Carron--Slvestre et al. (2005) and Im et al. (2005). However, we frstly consder whether t s worth to rely on the results from these PUR tests. Partcularly, homogenous PUR tests report the evdence regardng the bas and relatve low-power of these tests s now pretty strong, so the evdence that homogenous PUR tests provde may not be reled upon. On the other hand, the mpact of cross-sectonal dependence s lkely to be sgnfcant n regonal unemployment rates. So, we consder performng a formal test of cross-secton dependence, such as that proposed by Pesaran (2004). If the outcome supports the presence of cross-secton dependence, frst-generaton PUR tests (whch assume cross-secton ndependence) could be dropped n favor of second-generaton PUR tests. here are now a number of second-generaton PUR tests avalable n the lterature, but gven the small dmenson of the panel used n ths study, the relatvely smple test proposed by Pesaran (2007) would probably a good choce. Pesaran (2004) proposed the test statstc (CD) that t s an alternatve of LM statstc by Breusch and Pagan (1980), and t s defned for balanced panels as follows: N1 N 2 CD ˆ j (1) N( N 1) 1 j1 d He showed that under the null hypothess of no cross-sectonal dependence, CD N(0,1) for N and s suffcently large. hs test also offers a robust procedure n the small samples and the presence of structural-breaks. he CD test statstc may also be used when and N are large. We now apply the CD test procedure nto the regonal unemployment rates and we report fndngs as follows: 176

3 Internatonal Journal of Economcs and Fnance Vol. 4, No. 9; 2012 able 1. Results of Pesaran (2004) CD test for regonal unemployment n urkey Pesaran (2004) CD-stat (0.1134) Average absolute value of the off-dagonal elements Notes: CD test by Pesaran (2004) s defned under the null hypothess that cross-sectonal ndependence of regonal unemployment rates n urkey. he p-value s n parentheses. As we can see from able 1, the CD test by Pesaran (2004) nearly rejects the alternatve hypothess of no cross-sectonal dependence. hus, t can be sad that our fndngs from frst generaton PUR tests may be called as robust. We now consder a followng AR (1) process for panel data to defne frst generaton PUR tests (Quanttatve mcro software 2009, ): y t = y t-1+ X t + t (2) Where 1, 2,... N cross-secton unts or seres that they are observed over perods t 1, 2,... In ths smple equaton, X t represent the exogenous varables n the model, ncludng any fxed effects or ndvdual trends, are the autoregressve coeffcents, and t (the errors) are assumed to be mutually ndependent dosyncratc dsturbance. If 1, y sad to be weakly (trend) statonary. On the other hand, f 1 then y contans a unt root. here are two natural assumptons that one can make about the. Frst, one can assume that the persstence parameters are common across cross-sectons, so that for all. Bretung (2000), Hadr (2000) and Levn et al. (2002) tests employ ths assumpton. Alternatvely, one can allow varyng freely across cross-sectons. Im et al. (2003), and Fsher-ADF and Fsher-PP tests defne by Maddala and Wu (1999) and Cho (2001) are n ths form. Bretung (2000), Levn et al. (2002) and Hadr (2000) all assume that there s a common unt root process, so that s dentcal across cross-sectons. he frst two tests employ the null hypothess of a unt root, whle Hadr (2000) test uses the null of no unt root. Bretung (2000) and Levn et al. (2002) both consder the followng basc ADF specfcaton: p y y X t t 1 j y tj t t j1 (3) Where they assume a common 1 but allow the lag order for the dfference terms, to vary across cross-sectons. he null and alternatve hypotheses for the tests may be wrtten as H 0 : 0 H 1 : 0 so, under the null hypothess, there s unts root whle under the alternatve, there s no unt root. Im et al. (2003), the Fsher-ADF and Fsher-PP tests all allow for ndvdual unt root processes, so that may vary across cross-sectons. he tests are all characterzed by the combnng of ndvdual unt root tests to derve a panel-specfc result. Im et al. (2003) begn by specfyng a separate ADF regresson for each cross secton: p y y X t t 1 j y tj t t (4) j1 H 0 : 0 for all whle the alternatve hypothess s gven by H 1 0for 1,2, N 1 0 for N 1, N 2,... N (Where they may be reordered as necessary) whch may be nterpreted as a non-zero fracton of the ndvdual processes s statonary. An alternatve approach to PUR tests uses Fsher s results to derve tests that combne the p-values from 177

4 Internatonal Journal of Economcs and Fnance Vol. 4, No. 9; 2012 ndvdual unt root tests. hs dea has frstly been proposed by Maddala and Wuu (1999) and by Cho (2001). On the other hand, Carron--Slvestree et al. (2005) defne the Data Generatng Process (DGP) under thee null hypothesss of statonary n the varance. her approach ncludes (1) Indvdual effects that are n fact ndvdual structural-break effects (or shfts n the mean s caused by the structural-break) ( 2) emporal effects (3) emporal structural-break effects when there are shfts n the ndvdual structural tme trend. Carron--Slvestre et al. (2005) suggest that a structural-break specfcaton thatt t s general enough to alloww for unt-specfc ntercepts and tme trends n addton to unt-specfc mean and slope shfts. hs test s based on the null hypothess of a statonary PUR test by Hadr (2000). As we have already mentoned, Hadr (2000) desgns a test statstc that t s smply the average of the unvarate statonary test by Kwatkowsk et al. (1992) s KPSS. K Carron--Slvestre et al. (2005) compute the panel statonary test as the average of unvarate KPSS tests. hs test s computed as follows: (5) ˆ 2 2 t 2 ˆ 1 S, s the unvarate KPSS test for ndvdual and Sˆ t t, process that t s obtaned by usng the estmated OLS resduals of DGP. ˆ2 s the e consstent estmate of the long-run varance of resdual. Furthermore, Im et al. ( 2005) propose a standardzed Panel-LM unt root test statstc, followng the unvarate LM test by Lee and Strazcch (2003). Under the null hypothesss that an exstence of structural break, E ( L ) denotes expected value of LM. her test s computed as follows: LM N LM barn EL V( L ) Im et al. (2005) provde the numercal values for E( L ) and E( L ).he asymptotc dstrbuton of ths test s standard normal. hs test procedure s not affected by the structural break(s). 3. Emprcal Fndngs In ths secton, we frstly apply PUR tests, whch are proposed by Maddala and Wu (1999), Bretung (2000), Hadr (2000), Cho (2001), Levn et al. (2002) and Im et al. (2003) nto the regonal unemployment rates n urkey. hese PUR tests are used on the level of varable. rend s also accompaned n the emprcal analyss, because n the recent studes, a tme trend s ncluded n the PUR tests (Gozgor, 2011). We therefore employ the PUR tests ncludng constant and trend and results can be seen n able 2 as follows:, j ( ) t ˆ j 1 j, represents the partal sum (6) able 2. Results of PUR tests for regonal unemployment n urkey Cross Secton Independence Cross Secton Independence Homogenous Unt Roots Constant and rend Hadr (2000) Homogenous Z-stat * (0.0000) Hadr (2000) Heterogeneous Z-stat * (0.0000) Levn et al. (2002) t-stat (0.3246) Bretung (2000) t-stat (0.9870) Heterogeneous Unt Root Constant and rend Im et al. (2003) W-stat (0.8778) Cross Secton Dependencee Cross Secton Dependence Heterogeneous Unt Root Constant and rend Maddalaa and Wu (1999) ADF-Fsher Ch Square (0.9963) Cho (2001) ADF-Cho Z-stat (0.9914) Maddalaa and Wu (1999) PP-Fsher Ch Square (0.9822) Cho (2001) PP-Cho Z-stat (0.9808) Notes: PUR tests are defned under the null hypothess that non-statonary of regonal unemployment rates n urkey, except that Hadr (2000)( s defned as statonary. All PUR tests are defned by quadratc-spectral kernel and Andrews (1991) s bandwdth selecton. Heterogeneous test by Hadr (2000) assumes that the heteroskedastcty s consstent n PUR test. he optmal number of lag s chosen by Akake Informaton 178

5 Internatonal Journal of Economcs and Fnance Vol. 4, No. 9; 2012 Crteron (AIC). Probabltes for Fsher tests are computed by usng an asymptotc ch-square dstrbuton. All other tests assume asymptotc normalty. he p-values are n parentheses and * denotes the rejecton of the null hypothess at 1% sgnfcance. We also apply PUR tests by Carron--Slvestre et al. (2005) and Im et al. (2005) nto regonal unemployment rates n urkey. hese results can be seen n able 3. able 3. Results of structural break PUR tests for regonal unemployment n urkey Carron--Slvestre et al. (2005) est Statstcs 10% CV 5% CV 1% CV Break Date Homogenous Long-run Varance * Heterogeneous Long-run Varance * Im et al. (2005) est Statstcs 10% CV 5% CV 1% CV Break Date Unvarate Panel-LM test statstc Notes: CV: Crtcal Value. Carron--Slvestre et al. (2005) PUR test are defned under the null hypothess that statonary of regonal unemployment rates n urkey. CV n Carron--Slvestre et al. (2005) test s computed by the bootstrap dstrbuton by usng replcatons. As t s suggested by Camarero et al. (2006), bootstrap dstrbuton n Carron--Slvestre et al. (2005) test allows for the cross-sectonal dependence. he number of break pont(s) s estmated by the Modfed Schwarz Informaton Crteron (LWZ) by Lu et al. (1997). LWZ s allowed for maxmum two structural breaks. he global mnmzaton procedure of the sum-of-squared resduals by Ba and Perron (1998) s used to determne the break locaton(s) for each unt. Im et al. (2005) PUR test s defned under the null hypothess that non-statonary of regonal unemployment rates n urkey. Im et al. (2005) PUR test allows for the fxed tme effects and the regresson ncludes an ntercept and a tme trend. Structural-break denotes a shft n the level or n the ntercept. he optmal number of lag s chosen by the AIC n Im et al. (2005) test. * denotes the rejecton of the null hypothess at 1% sgnfcance. As we can see from able 2 and able 3, results from all PUR tests clearly show that exstence of hysteress effect n regonal unemployment rates n urkey. Furthermore, gven the short tme dmenson of the panel, one can suggest that usng of PUR tests allowng for structural breaks s not a good dea. Actually, these tests usually search for breaks n a subset of the avalable observatons, (e.g. by truncatng the frst and last 10% of the observatons), and ths s done to avod a stuaton n whch the detected structural-break reduces the pre-break or post-break perod to a small number of observatons. Unfortunately, n ths study, data for regonal unemployment rates n urkey s strctly lmted from 2004 to Concluson hs study frstly nvestgates whether regonal unemployment rates n urkey are determned by the hysteress hypothess or the NAIRU hypothess. In ths paper, we employ the panel unt root tests by Maddala and Wu (1999), Bretung (2000), Hadr (2000), Cho (2001), Levn et al. (2002), Im et al. (2003), Carron--Slvestre et al. (2005) and Im et al. (2005). All of these PUR tests show that the valdaton of the hysteress hypothess for the regonal unemployment rates n urkey. In other words, emprcal fndngs from the all eght PUR tests ndcate that the hysteress hypothess for regonal unemployment rates n urkey cannot be rejected. he man polcy mplcaton nduced from ths study s that a fscal or a monetary stablzaton polcy wll have permanent effects upon regonal unemployment rates n urkey. he mportant mplcaton of our fndngs comes from the fact that temporary shocks nto the regonal unemployment rates wll have permanent effects. hus, the demand-sde polces wll be substantally effectve n reducng the regonal unemployment rates n the long-run. Furthermore, t can be sad that our fndngs are well-ftted wth the unemployment background of urkey. References Andrews, D. W. (1991). Heteroskedastcty and autocorrelaton consstent covarance matrx estmaton. Econometrca, 59(3), Ba, J., & Perron, P. (1998). Estmatng and testng lnear models wth multple structural changes. Econometrca, 66(1), Blanchard, O. J., & Summers, L. H. (1986). Hysteress and the European unemployment problem. NBER macroeconomcs annual, 1, Cambrdge MA, MI Press. Bretung, J. (2000). he local power of some unt root tests for panel data. Advances n econometrcs, 15, Nonstatonary panels, panel contegraton, and dynamc panels. Amsterdam, JAI Press. Breusch, S., & Pagan, A. R. (1980). he Lagrange multpler test and ts applcatons to model specfcaton n 179

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7 Internatonal Journal of Economcs and Fnance Vol. 4, No. 9; 2012 Romer, D. (2006). Advanced macroeconomcs. hrd edton, New York: McGraw-Hl/Irwn. Smyth, R. (2003). Unemployment hysteress n Australan states and terrtores: evdence from panel data unt root tests. Australan Economc Revew, 36(2), Song, F. M., & Wu, Y. (1997). Hysteress n unemployment: evdence from 48 U.S. states. Economc Inqury, 35(2), Song, F. M., & Wu, Y. (1998). Hysteress unemployment: evdence from OECD countres. Quarterly Revew of Economcs and Fnance, 38(2), aylor, M., & Sarno, L. (1998). he behavor of real exchanges durng the post-bretton Woods perod. Journal of Internatonal Economcs, 46(2), Notes Note 1. See Romer (2006, ) for alternatve theoretcal models. Note 2. See statstcal features of regonal unemployment rates n urkey n Appendx A. Appendx A Statstcal features of regonal unemployment rates n urkey Year Natonal Average Mnmum Maxmum Standard Devaton