The Impact of Unemployment on GDP in Malaysia

Malaysia is a developing country and unemployment is a very important issue for developing countries. Based on the past researches where most of them states that unemployment rate does affect the nation’s GDP in a negative way where this statement was supported by the famous economist Arthur Melvin Okun, thus, this has created the theory of Okun’s Law. In this research, GDP, unemployment rate, inflation, government expenditure and physical capital will be used as the variables. The sample size will be 35 years where the period will be from 1982 to 2016 and most of the data were taken from World Bank and IMF. The purpose of conducting this research is to observe on the relationship between unemployment rate and GDP in order to validate Okun’s Law in Malaysia. Johansen cointegration test and VECM was implemented in generating the long run and short run result in order to fulfil the objective of this research. It was found that the model of this research shows that there are one cointegration long run relationship based on the maximum eigenvalue test from the Johansen cointegration test. Besides that, the VECM test has also proven short run relationship to exist in this model where the ECT value is -0.370133 showing that unemployment rate has a relatively slow impact in affecting Malaysia’s GDP. Through this research, it was also found that Malaysia’s Okun’s coefficient is -0.6434 which shows a negative relationship between unemployment and GDP, thus, proving the existence of Okun’s Law in Malaysia. Hence, this results actually suggested that unemployment rate does play an important role in determining the GDP level of the country regardless in terms of long run or short run.