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Cause And Affect Of Unemployment In Malaysia Economics Essay


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Unemployment is a very important issue for every country, especially developing country with a tremendous population. High unemployment means that labor resources are not being used efficiently. In consequence, full employment should be a major macroeconomic goal of government. This essential issue often being included in the government policy or agenda for parliament debate and discussion year after year. After a long period of discussion and debate, it seems no ultimate solution has been found to completely eliminate unemployment.

Theoretically, industrial economies are cyclically sensitive as such when it expands, factors including employment, sales, prices and profits will rise. However, when it contracts, downturns are inevitable and significant (Nazaria, 2003). When our national economy is in recession, many firms and companies are close down, it will cause unemployment rate to increase.

The financial crisis that started in mid 1997 has affected the Malaysian economy. The impact was evident with the economic growth measured in real GDP began to slow down and registered the first negative growth since 1985 of -7.4 per cent in 1998. Table 1 depicts real GDP growth, labor force and unemployment from 1996 -2003 (UKM Juru Perunding, 2002). The contraction in real GDP affected the labor market resulting in slower employment growth, increased in the unemployment rate and also retrenchment. Labor force registered negative growth of 2.1 per cent and employment declined by 2.8 per cent in 1998 compared to a positive growth of 4.9 and 4.6 per cent in 1996 and 1997, respectively. In the same year, unemployment, on the other hand, experienced a slight increase standing at 3.1 per cent. Retrenchment soared to 83,865 workers in 1998 compared to approximately 19,000 in 1997 (EPU, 1999).

Table 1: Real GDP Growth, Labor Force, Employment, Unemployment, Labor Force Participation Rates, 1996-2003

Sources: Nazaria B., 2003: Working paper of Unemployed Graduates: Pre and Post 1997


Okun's Law, stated that there is a negative relationship between unemployment rate and real GDP. Okun (1962) found that a deviation of 3 per cent in the GDP will produce a rise by 1 per cent in the unemployment rate. Besides that, Zaleha, Norashidah & Judhiana(2007) prove that Okun's Law can be applied to explain Malaysia's condition. Results of Table 2 showed that the value of the t-statistic for the coefficient (5.796) is greater than the critical t-value at the ninety five percent confidence level (1.96). This proves that GDP strongly depends on unemployment. Unemployment is one of the main mechanisms that can affect GDP. On the other hand, the result also confirmed that there is a negative relationship between unemployment and output growth. The Coefficient is -1.75 and it is significant at 1 percent level. It means that one percent decline in unemployment will increase output by 1.75 percent. As a result, it will increase the growth rate of the GDP.

Table 2: Results of Regression Analysis

Sources: Zaleha Mohd Noor, Norashidah Mohamed Nor & Judhiana Abdul Ghani

(2007). "The Relationship between Output and Unemployment in Malaysia: Does Okun's Law exist?" Department of Economics, Faculty of Economics and Management, Universiti Putra Malaysia,Pp.6

1.2 Objectives of the Study

The overall goal of the study is to examine the factors that cause and affect the unemployment in Malaysia. It is important to identify these factors in order to find solutions which can reduce unemployment rate.

The study aim to investigate the factors that cause unemployment such as consumption, investment, government spending and trade. They affect the supply and demand in the labor market. While economic recession may cause lack of job opportunity in the job market.

Moreover, this study also intends to develop some solutions to solve the problem of unemployment. It is expected that this study will achieve the research objective and highlight some important issues which relate to unemployment.

1.3 Organization of Research Study

This study is organized into 3 chapters that will address the overall objective of the research. Each chapter will also serve the purpose of delivering the research following its title.

Chapter 1 briefly introduces the research topic "Relationship between Unemployment Rate and Economic Growth in Malaysia". Meanwhile, the research objective will be to study the consumption, investment, government spending, as well as the trade that affect economic growth and caused unemployment in Malaysia.

Chapter 2 seeks to support the study by providing various relevant journals and articles on the area of interest of the research. This is also the proof of reading the literature relevant to the area of study.

Chapter 3 discusses the strategy and method used to collect the data. The research frameworks consist of four independent variables, which are consumption, investment, government spending and trade. Meanwhile, unemployment will be the dependent variable. Secondary data collected from Data Stream and research methods are decided.

1.4 Significant of Study

The information gained from this research will be able to provide valuable solution to reduce the unemployment rate in Malaysia. It will also provide Malaysia government with an idea on how important is to reduce the problem of unemployment rate. Reducing the unemployment rate may lead to a better economy in Malaysia due to the increase in productivity of Malaysia. A growth of national income, higher Gross Domestic Product (GDP) in Malaysia will then be achieved while the nations will have higher purchasing power and can lead to a better quality of life.

Investment, indeed, brings a lot of job opportunity in the country. Whenever foreign direct investments (FDI) invest in the country, there will be a lot of industry set up for production and administration. Thus labor demand will be increased due to the investment. It then decreases a certain amount of unemployed.

Another factor to reduce the unemployment is through the government spending. Government needs to build and construct many of the facilities in the country for the society's benefits. Government needs to spend on construction of big projects; this injection of money will help to create the job opportunity for the labor in the country.

Unemployment will be decreased.

Trade is one of the factors to reduce the unemployment as the working opportunity is created when two countries trade. Increasing of trade internationally meaning there will be an up surging of export. Thus, domestic supply of goods is needed to meet the international demand. From that, the people have an opportunity to produce and manufacture new product for the trade among the countries.

1.5 Research Question

The research question for the study would be "Relationship between Unemployment Rate and Economic Growth in Malaysia". Several independent variables affecting the unemployment rate will be investigated to see how actually it will influence the economic growth in Malaysia.

The details of the study are:

To study the consumption pattern affect the economic growth.

To investigate whether investment affect the unemployment rate.

To examine whether government spending affect the unemployment rate.

To study the effect of trade on the unemployment rate.

1.6 Problem Statement

Unemployment is a negative issue that may arise in every country around the world. As long as a person is involved in the labor market, he or she may one day become unemployed. Once unemployment issue is not solved, creation of problems to the unemployed graduates, nations, society and even the country will certainly arise. Furthermore, if the nation's unemployment continues to be severing, riots and insurgency will be occurring across the country and halting the country trading. A significant lost towards the nation will arise due to this serious problem. Solution for the unemployment problem is a priority of the government to include in the national economic planning and policy implementation. In this research, focus will be placed on how economic growth effects unemployment and their relationship.

Chapter 2 Literature Review

2.1 Definition of Unemployment

According to International Labor Organization (ILO, 2001), unemployed is persons who are above a specified age are without work, currently available for paid employment or self-employment, and actively seeking work.

There are three categories of unemployment,

Structural Unemployment

Structural unemployment is related to the mismatch in skills, as well as the inadequacy in locations or simply the wrong area desired for work, and interpersonal characteristics. For instance, as the technology is improving and changing in the market often causes many skills possessed to be obsolete. With the advancement of computer many jobs in manual book-keeping have been replaced by highly efficient and handy software.

Frictional Unemployment

Frictional Unemployment is resulting from temporary transitions made by workers and employers. This type of unemployment occurs when there are fresh graduates trying to enter the job market, searching for job of their choices.

Cyclical Unemployment

Unemployment that is attributed to economic contraction is called cyclical unemployment. The economy has the capacity to create jobs which increases economic growth. When the economy is in recession, firm will reduce production and it lead to the decline of labor demand. Thus, cyclical unemployment will rise sharply during recession.

2.2 Unemployment in Malaysia

It is essential to look at the unemployment trends in Malaysia for the period ranging from 2000 to 2009 (Figure 1). By observing the figure, unemployment rate remained moderate at approximate 3 percent.

Unemployment rate increases steadily from 2001 to 2004. On the year 2001, the 911 incident, US World Trade Centre was attacked by terrorists (Terence Tai-Leung Chong,2005). This attack marks the beginning of the US economy downturn. It then affects the whole world economy to decline. Being the largest economy in the world, US needs to import tremendously from the rest of the countries. Thus, US economy downturn has decreased its import and the world's export will decline as well. When the decline of export for the country, it will directly cause the down fall of the country's economic growth as the productivity has been reduced .Therefore, the global economy will be sluggish. Hence, unemployment rate in Malaysia is 3.7 percent on 2002.

During 2003, Malaysia was hit by double critical incidents which were Severe Acute Respiratory Syndrome (SARS) and Iraq War (Robert Evans,2003). Unemployment rate was 3.8 percent which has increased 0.1percent. There was an immediate effect from the outbreak of SARS and Iraq War due to the large amount of inter-regional trade. SARS and Iraq War have triggered a global downturn therefore affect the world economy into recession, and lowered world growth forecasts. SARS epidemic was concentrating in Asia which is the fastest growing economy in the world and that had basically been keeping the world economy to float.

Malaysia has gone through East Asia financial crisis during 1997. Thus, Malaysia has the ability to combat and survive during the sub-prime crisis. Some efforts of the policy maker have made to strengthen the domestic economy. Policy maker has implemented several monetary policy as well as fiscal policy to stimulate the economy. The increasing trend and steady growth in the Malaysia's Leading Index (LI) and the ratio of the Coincident Index to Lagging Index in 2007 (Public Bank Berhad,2007) indicates that the Malaysian economy was continue to remain strong and healthy in 2008 which US sub-prime mortgage crisis deceleration in the US economy.

Figure 1: Unemployment Rate in Malaysia

Sources: Indexmundi.com (2008). Malaysia - Unemployment rate (%). Retrieved


During a period of high unemployment, employees worry about losing their job and not able to get another job. Other than that, workers are less willing to leave unsatisfactory jobs because it is not easy to be hired at this current period. This may cause a decrease in production because workers are lack of experience in their current job. Higher unemployment rate will also affecting the government tax revenue. It is because there are more workers losing their jobs and leads to decrease in government revenue from income tax.

2.3 Factors that affect Unemployment

There are four independent variables that affect unemployment which are consumption, investment, government spending, and trade.

2.3.1 Consumption

Based on the study by Castillo, Dolado & Jimeno (1998), the result showed by using one cross-section of household per county, by comparing with the employed workers, the consumption losses suffered by the unemployed were 50% to 100% higher in Portugal and Spain, depending on the worker's job experience and skills. Besides, Bover et al. (2000) found that the unemployment benefits systems in Spain are more generous than in Portugal.

According to Samuel et al (2001), an increase in the duration of unemployment of male household heads tend to be connected with consumption losses in Germany, Great Britain, and the US than Spain and Italy. Also, in terms of 'married' households, Browning and Meghir (1991) found that the husband is unemployed in a married household have budget shares for clothing of 35% lower than the husband is being employed.

There are two authors have proven that consumption suffers downfall during unemployment. Cochrane (1991) reported a fall in consumption growth of 24% to 27% during unemployment. On the other hand, Browning and Crossley (2001) also proved that a mean fall in consumption of 14% on unemployment.

Browning and Crossley (2000) deal with the effect of income shock due to unemployment on consumption. Individuals experiencing an income shock may reduce consumption on durable expenditure than on food expenditure. For example, they may postpone to buy new jewelry or to replace new furniture.

2.3.2 Investment

According to Harms and Hefeker (2003), the returns of portfolio investment abroad are positively correlated with U.S. labor demand shocks. When there is more investment, it generates new jobs; therefore labor demand will increase accordingly. Thus, this will aid in the decrease of the unemployment rate.

Erkki Koskela, Rune Stenbacka, and Mikael Juselius (2009) study the effect of the unemployment equilibrium with capital investments under the category of labor market imperfections. By showing a higher capital, labor ratio has a wage-moderating effect with sufficiently strong labor market imperfections, the strategic effect of capital investments. Based on this appliance, an increased capital stock decreases unemployment equilibrium if the relative bargaining power of the labor union is sufficiently strong.

Marino (2000) showed the interdependency between FDI, economic growth, employment or explanation of factors for stimulating the FDI inflow in the case of open economies. The GDP growth is positively correlated with the capacity of FDI inflow. On the other hand, the relationship between GDP growth and FDI inflow is rather contrary in the case of closed economy.

Christoph Ernst (2005) studied that a country needs stable and productive investment inflows which would contribute to a rise in production rate and employment, to the technological modernization of the economy, as well as the production of higher value added goods resulting in a better integration into the world economy.

There is a strong correlation between national productivity and the level of unemployment (Joseph Prokopenko, 2000). In a situation where the economy is productive and competitive, there will be contest in the foreign market. Thus, it lowers the unemployment rate. However, investment will increase due to the high production rate. Then, it will create new job opportunities and the employment rate will increase as well. Hence, investing in a productive market is a source which can create new market and then increases the job opportunities in the market.

According to Borensztein, Gregorio & Lee(1998) and Yussof and Ismail (2002), FDI will introduce technology and management skill into the domestic firm to enhance the productivity. They may bring towards new technology into the domestic market. Thus, domestic labor will have a chance to upgrade and equip themselves with knowledge from the new technology and systems. FDI have positive effects on domestic unemployment, according to Lall (2002). FDI leads to increase the value of human capital accumulation. Labor will always get new knowledge from new technology so that they will be able to suit themselves into the specified occupations or jobs. Then, unemployment rate will decrease, hence, strengthening the economic growth of the country.

On the other hand, Blomstorm, Fors & Lipsey (1997) found that FDI will retain unskilled jobs at home country when more skill-intensive activities are allocated to the foreign country. Foreign investors will leave jobs which do not need much of labor skill work at their home country and relocate more labor-skilled works abroad. This way, the investors would be able to save in training cost by investing in foreign countries which have abundant skillful workers.

2.3.3 Government Spending

Government programs are the largest source of counterbalancing the income against household earnings shocks arising from the unemployment in the U.S. (Dynarski & Gruber, 1997). Agell, et al. (1997) noted that the government purchases and transfers can enhance employment thus strengthening and stabilizing the economic growth of the nation.

Spending on infrastructure will create more jobs opportunity (Kenyon, 1997). Government spending can raise labor productivity and also complements the investment from private sectors. Subsequently, the demand for labor will increase, hence, decreases the unemployment rate. The whole process of government spending is like a catalyst that can stimulate the overall economic activity and growth in the country.

According to Feldstein (1978), due to the unemployment insurance and taxation on labor income could deform work-leisure decisions, and it increases unemployment rates. Even if they do not have a job, they could still get the unemployment insurance to support their daily lives. Thus, this will result in a negative manner where labors will depend on the unemployment insurance instead of working hardly. On the other hand, the increase in income tax will lead to unemployment because income taxes charge according to personal income of individuals. The higher the income, the higher the taxes the person needs to pay. Everyone work so hard to get better income for a better life and yet they need to pay higher tax. Hence, there is this mentality where they would choose or decide not to work hard or be jobless, so that they would be able escape from being 'oppressed' by the government with income taxes.

2.3.4 Trade

According to Brecher (1974), the unemployment rate could rise or fall after trade depending mainly on whether the country exports labor-intensive goods or not. It shows under the Heckscher-Ohlin model. Davis (1998a, 1998b) further discussed about the effect in a two-country framework. If home country produces and exports labor intensive goods, then the employment rate will increase.

Matusz (1996) explored the consequences of opening to trade on the unemployment rate using the efficiency-wage framework. Open to trade will create intra-industry trade. It creates new jobs opportunity and then reduces the unemployment rate.

According to Brecher (1974) and Davis (1998), their study found that trade liberalization can reduce unemployment rate. Foreign workers are able to go to other countries anytime if there is no existence of the barrier of trade. Thus, a country's supply of labor will be excessive and it reduces tremendously, the job opportunity for domestic labors. Besides, frictional unemployment in comparative advantage model was introduced to find whether any relationship lay on a comparison of capital-labor benefit across countries (Davidson & Matusz 1988). For a country that produces capital intensive goods, labor skill is not in need for its production, thus, unemployment rate will increase.

Besides, fair wages has been introduced into a model with increasing returns to scale and trade liberalization of trade that would increase the unemployment rate (Egger and Kreickemeier, 2009). Labor wages in home country will be affected due to the excess in foreign labor supply. It reduces domestic wages and also reduces the chance of domestic worker to get a job at home country. As for one of the consequences, domestic unemployment rate will increase dramatically.

Helpman and Itshoki (2008) combined the comparative advantage consideration and increasing returns to scale by using search-matching approach. In conclusion, globalization can affect the increase of unemployment rate. Foreign workers can enter into the domestic labor market in a country, with cheap labor wages, that will result in the reduction of domestic wages as well as reducing the chance of domestic workers to get a job in their own country. Unavoidably, the domestic unemployment rate will increase.

According to Thomas (2004), Malaysia is heavily depending on foreign trades, the nation's exports account contributes large proportion of GDP, and manufactured goods are one of the main exports of Malaysia. As Malaysia is dependent on generating revenue through exports, many problems would occur if the exporting sector fails. Mainly, it will cause a major unemployment issue that would cause many of its people to suffer economic downfall. This is because manufacturing factories fail to sell and export their products, causing them to face financial problem. Therefore, it would result in the closing down of the factory, thus, the unemployment rate rises.

2.4 Unemployment Benefits in Malaysia

Unemployment benefits system is a benefit which is for eligible workers who become unemployed. Unemployment benefits consist of unemployment insurance and unemployment assistance. Unemployment benefits are available to the eligible unemployed only. The term "eligible" here means an unemployed individual which is in a condition of ready, willing and able to work on the go (Eva Liu, Walter and Kwong, 2000). Many studies have proven that unemployment benefits effectively smoothens consumption during unemployment. According to Gruber (1997), he found that the nation's budget on consumption expenditures would fall by 22 percent without the presence of unemployment insurance. It is proven from the study that unemployment could deteriorate not only the population's welfare but as well as the country itself. Furthermore, according to Kugler (2002), a study has made showing that the withdrawals from unemployment insurance savings account cause an increase of consumption level by unemployed household in Colombia.

Martin Borowing & Thomas Crossley (1996) discovered the impact of unemployment benefits to household welfare through the chain below. In general, their research study has concerned and included the overall link from unemployment benefits to its expenditures. As the result, they found out that a 5 percent cut in unemployment benefits level will cause an expenditure fall by 0.3 percent. The unemployment benefits as a major income for unemployed household have significantly larger falls in consumption. Also, some of the studies have been reviewed. For instance, the author reviewed Kell and Wright (1990) and Lundberg (1985) studies which were the relationship between personal income and household income depending on the reaction of earnings by other family members.

Unemployment Insurance benefits Personal Income Household Income

Household Expenditure Household Utility Level

However, Malaysia does not have any unemployment benefits system but the government has prepared a several types of welfare benefit system.

2.4.1 Severance Pay

Severance pay, in Malaysia, is regarded as a form of unemployment-related benefit for both employers and employees (Eva Liu, Walter and Kwong, 2000). Those workers, whose earnings which are not exceeding RM 1500 per month, irrespective of their earnings are covered under the employment Act 1955, will be provided for severance pay. Severance pay is known as retrenchment benefits, or termination and lay-off benefits in Malaysia. The rate is paid at the following rates:

10 days, 15 days, 20 days wages for each year of service for an employment shorter than two years, longer than two years but shorter than five years, five years or longer, respectively.

Severance pay is expected to be sufficient to meet the basic need of an unemployed worker until the next job is found. But, one must be clear that, severance pay is not equivalent to unemployment insurance or unemployment assistance.

Recipient employees do not need to have any prior contribution, neither the recipient employees are required to be able to work, nor willing to working or in the mode of finding work, in order for him to receive severance payment. Severance pay is made to an employee solely on the basis of termination of contract by the employer.

2.4.2 Employees Provident Fund

The Government has set up the Employees Provident Fund (EPF), a social security organization that provides retirement benefits to private sector employees and non-pensionable public service employees.  Under the Employees Provident Fund (EPF) Act 1951 (Malaysia,1951), it is compulsory for all employers and employees to contribute towards this Fund. Employer need to contribute 12% for his employee's EPF at the same time, employee need to contribute another 11% for himself from his monthly wages into his EPF savings.

This fund provides benefits for old citizens, disability and death. Nevertheless, it does not provide cash assistance to any employee who is unemployed and the money can only be withdrawn when one reaches the age of 55.

2.4.3 Work Injury Insurance

Work injury insurance is treated as a kind of employment related benefit in Malaysia. The Social Security Organization (SOCSO), a statutory body, administers payment of benefits under the Employment Injury Scheme and Invalidity Pension Scheme. The Employment Injury Scheme provides protection to employees who are involved in accident during work. On the other hand, Invalidity Pension Scheme provides 24 hours coverage for employees from invalidity or dies irrespective of the cause of death. Although these two schemes are not somewhat unemployment-specific, an unemployed worker could benefit under these schemes. That particular individual is covered whenever an injury or invalidity happens during his/her immediate past employment. This indirectly categorizes those two schemes, as the unemployment benefits system which is practiced by other countries (Eva,L.& Walter,K.2000).

2.4.4 Services for the Poor

In Malaysia, under the Destitute Person Act 1977, public assistance is available to households with monthly income of less than RM460. Families which suffer from poverty due to unemployment, aging, illness or even disability, may apply for assistance under this program (Eva,L.& Walter,K.2000).

2.4.5 Labor Laws

There are various labor laws in Malaysia that specify the obligations of employers with respect to the workers' benefits which is mainly related to sickness, maternity, and termination. In other words, basic protection, such as mentioned above, has to be provided by the employers for their employees. The principal labor laws on these matters are the Industrial Relations Act 1967, the Employment Act 1955 for Peninsular Malaysia, the Labor Ordinances of the states of Sabah and Sarawak. The formula for the benefits is specified in the relevant laws. Certain sectors have their standard cover or benefits for those who are related within the sector itself. For instance, those in the plantation sector are accorded certain minimum benefits such as housing and medical benefits the Workers' Minimum Standards of Housing and Amenities Act, 1990.(Soh C.S, 2007)

2.5 The effects of Unemployment on Social Issues

Unemployment is one of the major causes of many social and economic problems, such as the imbalance of social status among the populations or the increase of vice activities. Social problem is pin pointed in this discussion. Of many countries around the globe, Malaysia is not excluded from getting involved and dealing with crime offence issues every day. The phenomenon of crime wave has received an increasing attention and the criminal activity has been given wide coverage in the newspaper and media (Muzafar Shah Habibullah & A.H. Baharom,2008). As proposed by Becker (1968) and Ehrlich (1973), however, criminal activity in Malaysia does not attract the attention of the people across the globe and remains largely neglected by the economics of crime literature.

Economic condition seems to be one of the most important macroeconomic variables affecting crime. According to the economic models of crime such as Becker (1968), when a nation's economy is stabilized, fortified and becomes stronger, this would open more opportunities for the citizens to get themselves involved in the nation's workforce. When individuals earn their income legitimately, the possibility or tendency of an individual to get involved in crime related activities would be greatly decreased, thus, relatively decreases the crime rate.

According to Pichaud (1997), unemployment can cause a humongous social and economic cost to a country's budget. Every problem arises would have its consequences, for instance, when the unemployed are faced with financial problem, hence, those individuals will be in poverty and in debts due to the inability to pay up their levies. The matter would be worse for those individuals having to support their family members. Once the population is in the state of poverty, they would be thinking of possible ways, legally or illegally, to get money in order to support their daily life expenses. According to Ehrlich (1973), he predicted that when opportunity cost in illegal activity is low, then unemployed will get involved in criminal as they can get better payoffs. Therefore, there are certain kinds of criminal activity are directly linked to unemployment. Jahoda (1982) has linked unemployment to family disruption, suicide, health problem, drug addiction, malnutrition, poor prenatal care, school dropouts, racial and ethnic antagonism, and other possible social problems.

On the other hand, a study proved a relationship between GDP per capita and robbery rate. The study tells that an increase in GDP per capita is associated with a significant fall in the robbery rate (Fajnzylber, Ledeman, & Loayza,2002). This result supported by economic cycles which have a strong impact on crime. There is many other studies that prove and support the statement that strong economic performance may reduce criminal rate such as Pyle and Deadman (1994), Deadman and Pyle (1997), Hale (1998) and Masin and Masih (1996). Unemployment could affect the lifestyle of the society as this is strongly related to stress management. For an example, when unemployment occurs, this would increase the number of individuals losing their jobs and this may lead to self-medication with the consumption of alcohol (Winton, Heather, & Robertson 1986). This is also the root to many domestic problems lately. Family stress arising from poverty and unemployment has been found to be associated with children's behavioral problems and with their adjustment over time, especially at times when the family condition is being hit by the impact of unemployment (Shaw, Vondar, Dowdell Hommerding, Keenan, & Dunn,1994). However, the relationship between the consumption of alcohol and macroeconomic condition is indeed complex, as many factors get involved in the matter at the same time. For instance, income or wages being reduced as one of the consequences of unemployment may contribute to an increment in the consumption of alcohol. As explained, many factors would get involved in the matter, such as health. Based on the Australian and the overseas studies, they have unequivocally demonstrated a strong relationship between unemployment and health (National Health Strategy (1992) and Smith (1987)).

Chapter 3 Research Methodology

Research methodology is a set of procedures or methods used to conduct research. Under research method, some of the econometric method will be conducted for data analysis to develop this research study.

3.1 Theoretical framework

Theoretical framework is the outline which is how the independent variables and dependent variable are related. In this research, Unemployment is the dependent variable. The independent variables which are factors that affect unemployment are consumption, investment, government spending, and trade.

Figure 2: Factors that affect Unemployment in Malaysia

Independent Variables



Government Spending


Economic Growth

Dependent Variable


3.2 Sources of Data

In this research, secondary data will be use. Secondary data is data which is data that already exist. I will get my data from DataStream from the faculty lab.

3.3 Research Method

Research Method is the methods that I going to run test in order to develop this research model.

3.3.1 Unit Root Test

Unit root tests can be used to determine if trending data should be first differenced or regressed on deterministic functions of time to render the data stationary. A unit root means that the observed time series is not stationary. When nonstationary time series are used in a regression model one may obtain apparently significant relationships from unrelated variables.

3.3.2 Detrending Techniques

When there is nonstationary data, the Ordinary Lease Square (OLS) Linear Regression test will indicate the wrong result. In order to remove the linear trend, we need to detrend the model from nonstationary to stationary. Hodrick and Prescott Filter is a detrending method that I am going to use it in this research.

3.3.3 Ordinary Lease Square (OLS) Linear Regression Model

Regression analysis is to study the relationship between dependent variable and independent variables. Ordinary Lease Square model is to minimize Residual Sum of Squares and follow the assumptions of the classical linear regression model. OLS estimators are Best Linear Unbiased Estimators.

Chapter 4 Results and Discussions

4.1 Unit Root Test

Logarithmic levels

First differences





ln unemploy





ln C





ln I





ln G





ln Ex





Table 4.1.1 Unit Root Test at Logarithmic levels and First differences

Notes: ** denotes significance at the 5% level, *** denotes significance at 1% significance level and the rejection of the null hypothesis of non-stationary.

The unit root results shows that all the variables are fail to reject at the logarithmic level. This result implies that all the variables are not stationary at the logarithmic level. However, the results at the first difference show that all the variables are rejected at 1% and 5% level respectively except the government consumption variable. This result implies that all the variables have become stationary variables and the government consumption variable still remain as not stationary variables at the first difference level.

4.2 Detrending Techniques - Hodrick-Prescott Filter

Hodrick-Prescott Filter is used as detrending method in this research in order to remove the trend component from a time series trend. Hence, the application of linear detrending model to transform the data into stationary.

Figure 4.2.1: private consumption

Figure 4.2.2: Investment

Figure 4.2.3: Government Expenditures

Result shows that the data of private consumption, investment and government expenditures has upward trend. By using the Hodrick-Prescott Filter on the variables above which is private consumption, investment and government expenditures, all the trends can be removed. After detrending process, it has clearly shown that the movement of all variables have became fluctuating. Before detrending process, the trends of these three variables are difficult to observe, because the movement of trend of these three variables are captured by the time trend due to increasing over time. It means that the amounts of private consumption, investment and government expenditures are accumulated from year to year, so it will not able to observe whether it was increase or decrease.

Figure 4.2.4: Unemployment rate

Figure 4.2.5: Export

Figure 4.2.4 and figure 4.2.5 show the trends of unemployment rate and net export. Although the graphs show there are fluctuations for these two variables, but the cycles of these two variables show a clearer fluctuation after detrending. It is easier to see that whether the variables are increase or decrease.

4.3 Ordinary Lease Square

Table 4.3.1 Regression Output

Independent variable


Private Consumption




Government Expenditures


Net Export






Adjusted R2




Durbin-Watson-d Statistics


Jarque-Bera Test


Breusch-Godfrey Serial Correlation Test


Notes: *** Denotes significance at 1% level and reject null hypothesis

Coefficient of model: ln Unemploy = 0.0000000000000376 - 0.808474 ln C -

0.904420 ln I + 0.213398 ln G + 0.162743 ln Ex

The result of the regression analysis shows that all the variables are not significant except the investment variable is significant at 1% level. This result implies that the private consumption, government consumption and net export do not have significant relationship with the unemployment rate. On the other hand, the investment variable has showed a significant relationship with the unemployment rate. The coefficient of private consumption, government consumption and net export is inconsistent with the expected sign. The coefficient of investment variable is consistent with expected sign. From the result, it shows that investment is strongly affect the unemployment rate and the others variables are not affecting the unemployment rate.

The Adjusted R2 for the regression analysis is about 0.67. This result implies that about 67% of the variation in unemployment rate is explained by the private consumption, government expenditures, private investment and net export. The rest of 33% is explained by other factors such as interest rate, inflation rate, and etc. The F Statistics is Joint Hypothesis Test, and the result has shown that it is significant at 1% significant level. Therefore, at least one of the coefficients of independent variable is not equal to zero. All the variables show a positively relationship with the unemployment rate except the investment variable shows a negatively relationship with the unemployment rate. 1% increase in private consumption will increase the unemployment rate by 0.8085%. 1% increase in government consumption will increase the unemployment rate by 0.2134%. 1% increase in net export will increase the unemployment rate by 0.1627%. 1% increase in private investment will reduce the unemployment rate by 0.9044%. This result implies that when the private investment increases, companies will recruit more labor for the new investment and the unemployment rate decrease.

The regression result shown that private consumption is not significant to the unemployment rate. This because no matter people spend more or less will not affect the unemployment rate. The money spent by the private sector is not to hire labors, so it will not affect the unemployment rate. In fact, unemployment rate will affect the private consumption, when the unemployment rate is high, then it show that people are losing their jobs. Therefore, people without income are not able to spend or invest. Thus, private consumption will not affect unemployment rate but unemployment rate will affect the private consumption.

There are various type of unemployment, including cyclical unemployment, frictional unemployment, structural unemployment and classical unemployment. Some additional types of unemployment that are occasionally mentioned are seasonal unemployment, hardcore unemployment, and hidden unemployment. Real-world unemployment may combine different types. The magnitude of each of these is difficult to measure, partly because they overlap. The regression output shows that government expenditures do not affect the unemployment rate because there may be a frictional unemployment which is cause by the aggregate demand in the economy. For example, Demand for most goods and services falls, less production is needed and consequently fewer workers are needed, wages do not fall to meet the equilibrium level, and mass unemployment results. Other than that, the unemployment rate also may cause by frictional unemployment which involves people in the way of changing jobs. In this situation, even the government spends more will also not able to reduce the unemployment rate. All these reasons of unemployment are hard to control by the government.

The regression output also shows that net export do not affect the unemployment rate. This is because the international trade will not directly affect the unemployment rate. Volume of trade will show the country is in trade deficit or gained in the international market. The volume of trade whether more or less will not affect the unemployment rate in the country.

From the result above, only investment is 1% significant and it is strongly affect (-0.90) the unemployment rate. This proves that foreign direct investment is very important to a developing country. FDI may create jobs opportunities to the home country. When foreigners invest in that country, they will hire local labors. This may reduce the unemployment rate in that country. Therefore, investment has negative relationship with the unemployment rate.

Chapter 5 Conclusion and Recommendation

5.1 Conclusion

This research is to examine the relationship between unemployment rate and economic growth in Malaysia. The theoretical framework has given the model to examine the relationship between unemployment with the economic growth which is consumption, investment, government spending and trade. According to the test conducted in the data analysis part, the Unit Root Test has demonstrated some of the variables and became stationary after first differentiated. Thus, the Ordinary Lease Square (OLS) regression will be valid in estimation.OLS regression is tested on the relationship between the independent variables and dependent variable. On the other hand, the Hodrick-Prescott Filter has succeeded to remove the unobservable trend of variables. Through the empirical result, the analysis shows that there is a positive relationship between the investment and unemployment, which the relationship is found to be significant.

In conclusion, this research is to understand the relationship between economy activities and unemployment rate is particular important in developing country like Malaysia. This research shows that foreign direct investment is the main factor to affect unemployment. Malaysia's government should attract more FDI inflows so that it can create jobs opportunity and decrease the unemployment rate in domestic. Besides, it will also improve the living standard of Malaysian. This research may contribute to the future studies for decrease of unemployment rate in Malaysia.

5.2 Recommendation

Investment plays an important role in order to reduce unemployment rate in Malaysia. Foreign direct investment (FDI) has brought in capital investment, technology and management knowledge needed for economic growth. So, lots of firms will be setting up, a huge number of workers are needed. In consequence, the demand for labor will increase and the unemployment rate will decrease. Furthermore, the advance technology in production will train more skillful labors. As a result, it will enhance the productivity of the firm. In future, Malaysians are able to produce high quality goods and services as foreigners do.

However, the entry of foreign investors will cause negative effect on domestic producer. Domestic producer will be facing some problems if there are too many foreign investors in the market. When the foreign investor becomes monopoly in domestic market, domestic producers are losing the market power. The foreign producers can achieve economic scale with the advance of technology, so this will cause domestic producers hard to survive in domestic market in long term. Government plays an essential role in this case. The government may impose relevant policies such as joint ventures. Domestic producers are given the opportunities to become a part of the joint venture company and they can also share the profit that earned.

According to W.M Har, K.L Teo and K.M Yee (2008), the key success factor of the FDI contributes to the economic growth in Malaysia because of the good environment. Without a suitable environment, it will discourage foreign investors to invest in Malaysia. Some trivial matter problems can be avoided in a good favorable condition environment, so that the investors can run their business conveniently in order to make more profit with life safety. Few crucial clues for foreign direct investment include political stability, economic stability, lower wages, easy accessibility of plentiful raw material, special rights, and personal safety

In conclusion, Government needs to maintain political and economic stability and implement policy that can protect domestic producer and meanwhile attract more foreign investors where the government has to concern the importance of FDI contribution to the economy of the country as well as its impact on the unemployment rate. Besides, government needs to create more new jobs opportunity, so as to ensure that jobs are match to jobseekers' talent and skill.

5.3 Research Limitation

There are some limitations in this research. Firstly, this research has limited to four independent variables only. There are many factors that can affect the unemployment rate, which are inflation and wages. Furthermore, this research is insufficient of the data analytical method which this study only focus on three research methods, which are Unit Root Test, Detrending Techniques, Ordinary Lease Square (OLS) Linear Regression Model. The Augmented Dickey-Fuller, Phillips-Perron and KPSS tests are not used as the model in analysis as it is not within the knowledge acquired as these test can portray a complete result.

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