Okun's law among Spanish regions: A spatial panel approach

The Great Recession of the late 2000s has brought to the fore the relationship between economic activity (proxied by GDP) and labor market developments (proxied by unemployment rates), namely the so-called Okun’s law. Most papers devoted to this issue have been carried out at the country level, suffering consequently serious problems of aggregation. This paper, however, adopts a regional perspective and, by using the Spanish case as a sort of laboratory, analyzes Okun’s law at the regional level (EU NUTS2) over the period 1996-2011. The relevance of this case study is quite evident: Spain is one of the countries with higher and more persistent unemployment rates and, therefore, the implementation of adequate policies to address the situation of the labor market is one of the main goals of Spanish national and regional policymakers.

The paper begins by explaining different specifications of Okun’s law. Here another important point of this paper, related to methodological issues, emerges. In order to detect the existence of spatial spillovers, a usually neglected point in this branch of the literature, the paper estimates a Panel Spatial Durbin Error Model. By doing this, the total effect of GDP changes on unemployment rates can be divided between direct and indirect effects, the latter capturing spillover effects.

Then, a brief description of the data used, collected from the Spanish National Statistics Institute (INE),  is offered so the reader gains knowledge about Spain, its regional classification and the existence of remarkable differences between regions regarding both unemployment rate and GDP growth. Based on the “spatial” specification of Okun’s law, the results show that an inverse relationship between unemployment and output holds for most of the Spanish regions. However, the values of Okun’s coefficients for these regions are quite different, a noteworthy result from a policy point of view. In addition, our findings reveal the existence of remarkable regional spillovers between Spanish regions.

Finally, some policy remarks are offered. Regarding the direct effects, there is the need to implement policies devoted to reducing the unemployment rate and to boost productivity. On the other hand, there are also policy implications focused on the presence of spatial spillovers. In particular, the paper pays special attention to the fact that policies implemented at the regional level have effects not only on the region itself but also in other regions, something that without any doubt should be considered by policymakers.