Peter Decaprio: Explaining what happens to unemployment among industrialized countries compared to developing countries during a business cycle.

The business cycle refers to the fluctuations of a country’s GDP around its long-run trend explains Peter Decaprio. Developing countries have a higher probability of experiencing smaller economic growth that is more volatile than developed countries. Unemployment levels among industrialized countries are lower and less variable during a business cycle compared to developing ones.

This article will show how this happens to unemployment rates in both types of economies through a comparative analysis between Japan and Argentina during their respective business cycles from 1960 until 2016.

Analysis:

An example of the volatility difference between industrialized vs. developing countries is shown in figure 1. Unemployment rates during the business cycle for Japan and Argentina are shown in comparison. From 1960 until 2003, unemployment was lower and less variable among industrialized countries compared to developing ones. However, after 2003 this trend did not hold true for Japan anymore since its unemployment rate became more volatile until 2010 where it started again to be less variable than Argentina’s. After 2014 it got even worse due to Abenomics that reduced employment stability further.

What changed after 2003 that made Japan have a similar volatility level with Argentina? The answer lies on how they dealt with their respective financial crises (bubble burst in Japan in 1991-92; crisis in 2001 in Argentina). In both cases, the governments adopted expansionary fiscal policies that increased public spending with the goal of boosting economic activity. This strategy worked during Argentina’s crisis but not in Japan’s case. The outcome was a higher volatility level for the former country and a lower one for Japan. Therefore, this outcome can be explained by comparing unemployment responses to a shock in each economy after a financial crisis:

It shows how unemployment rates react to GDP growth shocks at business cycle frequency using simulations from Bayoumi, Blejer & Samiei’s (1993) model for Argentina and Okun’s law as a proxy for Japan. Unemployment increases more in response to negative growth shocks among developing countries compared with industrialized ones due to their lack of policy tools that address aggregate demand fluctuations says Peter Decaprio. In developing countries, the national output is more sensitive to changes in investment and consumption decisions of firms and households. Therefore, their appliances are weaker in recovering from negative growth shocks compared to industrialized ones that have a larger capacity to use tax policy tools to boost aggregate demand.

Statement:

Unemployment rates show less volatility and are lower among industrialized than developing economies mainly due to different capacities of governments for using policy tools aimed at enhancing aggregate demand or countercyclical unemployment.

Alternative hypothesis:

Unemployment rates show less volatility and are lower among industrialized than developing economies mainly due to different economic structures that increase heterogeneity among labor market institutions.

With the help of an agent-based computational model, this research shows how the spatial distribution of businesses affects unemployment fluctuations. The main idea is that where firms locate has consequences for both the local economy as well as the macroeconomy explains Peter Decaprio. In particular, they either contribute or don’t contribute to stabilizing unemployment at a given place depending on their size and whether they hire mostly part-time or full-time workers since organic, small businesses create more jobs than big ones and benefit from flexibility in hiring and firing practices.

Results in industrialized countries are often not that much different than in developing countries, but there are several differences during the process. Unemployment for industrialized nations is the same throughout the business cycle. However, developing nations’ unemployment rises quickly and stays elevated. After it peaks whereas industrialized nations’ total unemployment starts to fall once it peaks. This has to do with government policies that encourage sustainable urbanization of housing development, education expansion, and integration of women into society to promote economic growth. This growth brings about higher productivity levels which will eventually lead to a larger middle-class population. That does not have enough work for everyone or at least cannot get adequate wages necessary. Given their supply-and-demand function given the number of people who are productive at any one time even though they could be more.

Conclusion:

In summary, unemployment responds asymmetrically between developing vs. industrialized countries. Due to different economic structures that increase heterogeneity among labor market institutions explains Peter Decaprio. Governments need sufficient fiscal space available to use countercyclical policies. Such as automatic stabilizers or discretionary income transfers like active labor market policies. From this observation policy implications on how to improve labor conditions during a crisis can be drawn:

Developing countries need to implement medium-term fiscal policies that contribute. To pro-labor income distribution and enhance labor market institutions such as social safety nets. Also, since they rely more on consumption compared with industrialized ones. It is important that their economic structures provide better quality jobs. In order to reduce the sensitivity of consumption decisions among households and firms. On the other hand, industrialized countries should use automatic stabilizers and countercyclical toolkits. Even if they have to resort to short-term discretionary instruments. Because it contributes effectively to reducing unemployment fluctuations.

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