Examine The Relationship Between The Unemployment Rate And Inflation In Nigeria: Testing Philips Curve

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Examine The Relationship Between The Unemployment Rate And Inflation In Nigeria: Testing Philips Curve


Abstract


This study investigated the relationship between unemployment and inflation in Nigeria from 1980-2012. The model specified unemployment as a function of inflation, money supply % GDP, total government expenditure % of GDP. The statistical tests used were causality test, VECM test, co integration test. Based on the above tests carried out, the study found out that: (i) Inflation significantly impacted unemployment in Nigeria both in the long run and short run within the period under review.(ii) There exist a significant causal relationship among the variables in the model. Based on the results, the study recommended that government should use discretionary policy that would reduce unemployment by boosting government expenditure and maintain stability in money supply.


Chapter One


Introduction

1.1 Background of the Study:

Undoubtedly, parts of the macroeconomic goals which the government strives to achieve are the maintenance of stable domestic price level and full-employment. Macroeconomic performance is judged by three broad measures- unemployment rate, inflation rate, and the growth rate of output (Ugwuanyi, 2004).

Unemployment has been categorized as one of the serious impediments to social progress. Apart from representing an enormous waste of a country‟s manpower resources, it generates welfare loss in terms of lower output thereby leading to lower income and well-being (Raheem, 1993).

Inflation on the other hand, has been a major problem in the country over the years. Inflation is a household word in many market oriented economies. Although several people, producers, consumers, professionals, non-professionals, trade unionists, workers and the likes, talk frequently about inflation particularly if the situation has assumed a chronic character, yet only selected few know or even bother to know about the mechanics and consequences of inflation.

Prior to the emergence of what became to be known as the unemployment and inflation trade-off or Phillips curve in 1958, unemployment and inflation were considered and treated in economics as distinct subjects. Keynes for instance described inflation as the excess of expenditure over income at full-employment level. He contended that the greater the aggregate expenditure, the larger the inflationary gap and the more rapid the inflation. As for unemployment, the Keynesian economists hold that an increase in unemployment reduces income, which reduces consumption, and reduces aggregate output. As a result, employment can be increased by increasing consumption or investment.

The monetarist on the other hand, explained inflation in terms of excessive growth of the money supply relative to real output. Their view on unemployment, however, is framed within the context of Milton Friedman‟s permanent income hypothesis. Based on the Permanent Income Hypothesis (PIH), a reduction in employment and current receipts only affects output to the extent that the anticipated income declines.

Each school of thought offered its own policy solutions. There were however, no major attempts made to examine inflation and unemployment simultaneously.

It was not until 1958, following the introduction of Phillip‟s curve by A.W. Phillips, that traditional economics began to examine unemployment and inflation simultaneously, thereby postulating a trade-off between inflation and unemployment- a lower inflation rate must be willing to put-up with a higher level of unemployment, and vice-versa. However, economists such as Milton Friedman and Edmund Phelps disapproved Phillips‟ curve thesis, stating that the trade-off between unemployment and inflation only existed in the short-run and that in the long-run, the

Phillips curve is vertical. This led to the introduction of the Natural Rate Hypothesis.

Also, empirical analysis carried out by other economists over the years, have in one way or the other disproved the authenticity of the trade-off thesis as postulated by Phillips. Both high inflation rates and high unemployment rates were discovered to co-exist, giving rise to what has come to be known as stagflation. These twin problems are currently crucial elements of most Less Developed Countries‟ economic crisis.

Unemployment and inflation are issues that are central to both the social and economic life of every country. The existing literature refers to unemployment and inflation as constituting a vicious circle that explains the endemic nature of poverty in developing countries. And it has been argued that continuous improvement in productivity- which brings about the adequate supply of goods and services – is the surest way to breaking the vicious circle.

The Nigerian experience of the crisis of unemployment and inflation was delayed until the early – and mid- 1980s with the collapse of oil prices on which the economy had become dangerously dependent on. Before the 1980s, previous records showed that the Nigerian economy was able to provide jobs for its increasing population, and was able to absorb considerable imported labour in the scientific sectors. The wage rate compared favourably with international standards, the inflation rate was moderate, and there was relative industrial peace in most industry sub-groups.

The oil boom in the 1970s led to the mass migration of youths into the urban area, seeking to get work. However, following the recession experienced in the 1980s, the available data revealed that, the problem of unemployment started to manifest, precipitating the introduction of the Structural Adjustment Programme (SAP), the rapid depreciation of the naira exchange rate and the inability of most industries to import the raw materials required to sustain their output levels.

A major consequence of the rapid depreciation of the naira was the sharp rise in the general price level (inflation), leading to a significant decline in the real wages. The low wages in turn fuelled a weakening purchasing power of wage earners and a decline in the aggregate demand. Consequently, industries started to accumulate unintended inventories and, as a rational economic agent, the manufacturing firms started to rationalize their market prices. With the simultaneous rapid expansion in the educational sector, new entrants into the labour market increased beyond absorptive capacity of the economy. Thus, the avowed government‟s objective of achieving “full employment” failed.

The research work is therefore intended to access the applicability of the trade-off thesis in Nigeria.


1.2 Statement of the Problem

Anthony De Mello, in his famous book titled „Awareness‟ stated that, “Life is a banquet. And the tragedy is that most people are starving to death”. This situation is prevalent in the Nigerian economy. Nigeria is richly blessed with abundant human and natural resources, but still finds itself battling with high unemployment and inflation rates, due to years of neglect of the social infrastructures and general mismanagement of the economy. Previous governments in their own capacities have been embarking on various policies to control inflation and reduce the level of unemployment in the country. However, government efforts have not yielded the desired results as these problems are known to be skyrocketing rather than plummeting.

The problem of inflation in Nigeria was brought about by the oil glut in 1981, which resulted into balance of payment deficits leading to foreign exchange crisis that necessitated various measures of import restrictions. These restrictions reduced raw materials for domestic production and spare parts for machinery operation. The resultant shortage of goods and services for local consumption spurred the inflation rate to rise from 20% in 1981 to 39.1% in 1984 (Itua, 2000).

With the adoption of the Structural Adjustment Programme (SAP) in 1986, there was a temporal reduction in fiscal deficits as government removed subsidies and reduced her involvement in the economy. But as the effects of the Structural Adjustment Programme (SAP) policies gathered momentum, there was a fall in the growth rate of Gross Domestic Product (GDP) in 1990 from 8.3% to 1.2% in 1994, with inflation rising from 7.5% (1990) to 57.0% (1994). In 1995, inflation rate rose to 72.8% due to increased lending rate, the policy of guided deregulation, and the lagged impact of fiscal indiscipline.

The increase in unemployment in Nigeria, on the other hand, has resulted to decrease in consumption, due to low income earned by the citizens, thereby resulting to low production- the inability of firms to sell their goods, forces them to reduce their output. This has led to decrease in the economic growth of the nation.

Unemployment also has social consequences as it increases the rate of crime. Also, being without a job in Nigeria, is as good as losing your self-respect and self-esteem among the people of your age bracket. The proportion of workers who are unemployed shows how well a nation’s human resources are used and serves as an index of economic movement (positive or negative).

In 1999, the unemployment rate was 17.5%, while at the end of President Olusegun Obasanjo‟s administration in 2007; the rate of unemployment had reduced marginally to 12.7%. From 1999 to 2007, the rate of unemployment averaged at 13.1% – still quite high, since 5% is perceived as the accepted rate. In 2008, the rate of unemployment was almost 14.9% and rose drastically to about 23.9% in 2011. The unemployment rate has been rising from 1980 to 2011. A recent forecast shows that the rate would continue to increase up to the year 2020.

In the light of the foregoing analysis, the research work will be guided by the following question:

  1. Is there any trade-off relationship between unemployment and inflation in Nigeria?
  2. Does government expenditure have any significant impact on unemployment?
  3. Do increases in the gross domestic help reduce unemployment?

1.3 Objective of the Study:

The primary objective of this study is to examine if there is any trade- off relationship between unemployment and inflation in Nigeria.

Other objectives include;

  1. To ascertain the impact of government expenditure on unemployment.
  2. To examine the impact of gross domestic product on unemployment.

1.4 The Research Hypothesis

The study will be guided by the following hypothesis;

  1. Null hypothesis (Ho): There is no trade-off relationship between unemployment and inflation in Nigeria.
  2. Null hypothesis (H0): Government expenditure has no impact on unemployment in Nigeria.
  3. Null hypothesis (H0): Gross domestic product has no significant impact on unemployment in Nigeria.

1.5 Significance of the Study:

Why has unemployment and inflation continued to rise despite the substantial increase in the nation‟s GDP? Is it that successive governments neglected the issue of unemployment and inflation or has the twin problems defied all economic theories? These are questions that need immediate answers, because unemployment and inflation are current issues that is affecting our country and which is being discussed by both experts and lay-men alike.

Therefore, this study will be of paramount importance to economic decision-makers, as it will equip them with the knowledge and skills needed to tackle the pressing issue of unemployment and inflation in our country. Also, to those who would like to carry out further research on this topic, it would be of valuable help in the course of their research.


1.6 Scope of the Study

The research work intends to study unemployment and inflation situation within the Nigerian economy. The study will cover the time period 1986-2011 (a period of 25 years); this is to ensure updated information and to follow the trend. The range was chosen based on data availability and to have adequate observation for a meaningful analysis.


1.7 Limitations of the Study

When carrying out research in social sciences, the data that one generally encounters are non-experimental in nature, that is, not subject to the control of the researcher. Therefore, this lack of control may create special problems for the researcher in pinning down the exact relationship that exists between unemployment and inflation in Nigeria.

In the course of the study, the researcher tried to access the CBN statistical bulletin of 2010, but was unable to get data for the figures of unemployment and inflation in 2011. He therefore resorted to accessing the internet for the missing figure for 2011. The researcher also encountered the challenge of inadequate and incomplete information from the internet and the school library. The researcher was also faced with the problem of unavailability of funds to carry out the research work.


Chapter Five


Summary of Findings, Conclusion and Policy Recommendations

5.1 Summary of Findings:

The research work is centered on unemployment and inflation in Nigeria. Its main objective was to ascertain if the trade-off thesis holds in Nigeria. To achieve this, various data on unemployment and inflation were collected from 1986-2011, also other variables such as government expenditure, interest rates, and the gross domestic product were included. These variables were then subjected to multiple regression analysis, using OLS estimator, with unemployment as its dependent variable. The summary of the findings are given below;

  1. Inflation was found to conform to the a priori expectation, by having a negative sign. Its significance test revealed that inflation has a significant impact on unemployment in Nigeria.
  2. Interest rate and gross domestic product conformed to the a priori expectation, by having positive and negative signs, respectively. Furthermore, the result also revealed that both variables have no significant impact on unemployment, when they were subjected to the individual significance test.
  3. Government expenditure on the other hand, did not conform to the a priori expected sign. When subjected to the individual significance test, it was found that it has a significant impact on unemployment.
  4. The goodness of fit test revealed that inflation, government expenditure, interest rate, and gross domestic product explain 77.1% of the dependent variable (unemployment), which is a good sign.
  5. Also, the general significance of the model, using the F-test, showed that the model is good and could be used for forecasting.

5.2 Conclusion

Unemployment and inflation poses a serious problem in any economy. Studies carried out by most economists revealed that in the quest to reduce unemployment, rising inflation may be risked. A. W. Phillips‟ research work (1958) attested to this fact of trade-off relationship. However, some other economists led by Milton Friedman challenged the trade-off relationship thesis, saying that it existed only in the short-run, that in the long-run, the Phillips curve is vertical without any sign of trade-off relationship. Friedman used the term natural rate of unemployment‟ in his analysis to denote the rate at which the actual rate of inflation equals the expected rate of inflation.

The researcher in other to validate the existence of a Phillips curve carried out various tests, using the Nigerian economy as a case study. The result of the test revealed that unemployment and inflation are inversely related, thus confirming the existence of the Phillips curve in Nigeria, with inflation having a significant impact on unemployment in Nigeria.


5.3 Policy Recommendations

The trade-off relationship between unemployment and in inflation poses a dilemma for our policy formulators, since in order to reduce unemployment, the inflation rate in the economy tends to rise. Thus, of great importance is the need for constructive and well-specified policy recommendations that will help to ameliorate the situation of unemployment and inflation in Nigeria. Below are some policy prescriptions, which will help alleviate the current problems of unemployment and inflation in Nigeria.

  1. Government should strive to develop the agricultural sector which has great potentials to increase the supply of farm products and other basic necessities of life. The increased supply will reduce prices and increase in employment generation. To achieve this, various specific agricultural policy measures should be promoted and pursued vigorously.
  2. Massive investments should be carried out in the real sector of the economy, by establishing job-creating industries, which will help to reduce the level of unemployment in the country, increase output, reduce prices of goods and services, and thus, reducing the level of inflation in the economy.
  3. The free flow of information between employers and employees should be enhanced, through the reduction in the cost of job or employee search by means of job data banks, thus resulting to increased efficiency in the labour market. Similarly, training and educational programmes should be increased and geared towards innovations and productivity, thereby, reducing the rate of unemployment in the economy.
  4. It is also recommended strongly that special attention be given to policy implementation. In this regard, the government should set up a policy implementation body or committee in the presidency for the purpose of monitoring government policies and ensuring that they are implemented according to prescriptions.

Examine The Relationship Between The Unemployment Rate And Inflation In Nigeria: Testing Philips Curve


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Frequently Asked Questions


What happens to inflation when unemployment rises?

When unemployment rises, the inflation rate will possible to fall. This is because: If the unemployment rate of a country is high, the power of employees and unions will be low. Then, it is hard for them to demand their labor power and wages because employers can rent other workers instead of paying high wages.

Who first identified the relationship between unemployment rate and inflation rate?

This relationship was first identified by A.W.Philips in 1958. Low unemployment rate and low inflation rate are ideal for the development of a country; then the economy would be considered stable.

What happens to the Phillips curve when unemployment decreases?

If levels of unemployment decrease, inflation increases. The relationship is negative and not linear. Graphically, when the unemployment rate is on the x-axis, and the inflation rate is on the y-axis, the short-run, Phillips curve takes an L-shape. It can be shown by a graph as below.

What is the relationship between employment and inflation?

Employment is often people’s primary source of personal income. So employment impacts the consumer spending, standard of living and overall economic growth. Inflation can be defined simply as the rate of increase in prices for goods and services. We use different measures to calculate inflation. 

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