Paper#2

2940605: Quantitative Methods in Economic Analysis

Application of Dummy Variable models

A Paper
On
Relationship Between Hourly Compensation in
Manufacturing and Unemployment Rate in the
United States, Canada and the United Kingdom

BY
SK. ASHIQUER RAHMAN
ID#4585974929

A Thesis Submitted In Partial Fulfillment of the Requirement for the Degree of Masters in
International Economics and Finance

TO,
DR.BANGORN TUBTIMTONG
ASSISTANT PROFESSOR

Masters in International Economics and Finance

Faculty of Economics,
Chulalongkorn University, Phayathai Road,
Bangkok-10330,Thailand.Tel: (662) 218 6295, (662) 218 6218,Fax:(662) 218 6295,
E-mail: ief@chula.ac.th, http://www.econ.chula.ac.th/programme/ma_inter.html
 UNEMPLOYMENT RATE AND COMPENSATION  2002  

Letter of Transmittal

June 3, 2002
Dr.Bangorn Tubtimtong
Assistant Professor,
Masters in International Economics and Finance
Faculty of Economics,
Chulalongkorn University,
Phayathai Road, Bangkok, Thailand

Subject: Letter of Transmittal.

Dear Madam,

Here is my paper on "Relationship between Hourly Compensation in Manufacturing and

Unemployment Rate in the United States, Canada and the United Kingdom” that I was
assigned. It was a great opportunity for me to acquire practical knowledge of the Quantitative
Methods in Economic Analysis and forecasting

I have concentrated my best effort to achieve the objectives of the report and hope that my
endeavor will serve the purpose.

I believe that the knowledge and experience I have gathered during my paper preparation will
immensely help me in my professional life. I will be obliged if you kindly approve this effort.

Sincerely yours,

Sk. Ashiquer Rahman

Id#4585974929
Chulalongkorn University
Masters in International Economics and Finance
Bangkok, Thailand
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 UNEMPLOYMENT RATE AND COMPENSATION  2002  

Preface

Any institutional education would not be completed if it were confined within theoretical aspects.
Every branch of education has become more competed by their practical application and
accomplishment of full knowledge. We shall be benefited by our education if we can effectively
apply the institutional education in practical fields. Hence, we all need practical education to apply
theoretical knowledge in real world. By considering this importance “faculty of economics”
arranges the Quantitative Methods in Economic Analysis courses for the students of Masters in
International Economics and Finance. As a part of this program my topic was selected as
“Relationship between Hourly Compensation in Manufacturing and Unemployment Rate in
the United States, Canada and the United Kingdom.”

I tried my best to conduct an effective study by arrange and analysis data. There may be some
mistakes, which are truly unintentional. So, I would request to look at the matter with merciful
mind.

Sk. Ashiquer Rahman

Id#4585974929
Chulalongkorn University
Masters in International Economics and Finance
Bangkok, Thailand

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 UNEMPLOYMENT RATE AND COMPENSATION  2002  

Acknowledgement

First, all praises go to almighty Allah, the most gracious, the most merciful to give me the ability for
all these I have done.

Then I would like to thank Ms. Wanwadee Wongmongkol. Now I would like to thank
Dr.Bangorn Tubtimtong Assistant Professor, Chulalongkorn University, Phayathai Road,
Bangkok,Thailand to give me the opportunity to do this project.

I would also like to thank Professor. Paitoon Wiboonchutikula, Ph.D ,Associate professor and
Chairperson of Faculty of Economics, Chulalongkorn University & Professor Salinee. Secretatery
international economics and finance. My striking thanks go to honorable sir Dr. MN.Sirker who
has helped me in all aspect to prepare the report.

I would like to thank lab incharge Ms. Mink . Last but not the least I wish to thank my
friends, William Lloyed ,Nakarin and Athipat, for their very helpful discussions.

Sk. Ashiquer Rahman

Id#4585974929
Chulalongkorn University
Masters in International Economics and Finance
Bangkok, Thailand

iv
 UNEMPLOYMENT RATE AND COMPENSATION   
2002

Table of Content

Title Page

Letter of Transmittal ii

Preface iii
Acknowledgement iv
Table Of Content v
List Of Tables vi
List Of Figures vii
Acronyms And Abbreviation/ Contraction/Symbols viii

Statement Of The Problem 1-1

Literature Review 1-1

Formulation Of General Model 1-2
Data Sources &Description 2-11
Model Estimation And Hypothesis Testing 12-16
Interpretation Of The Results And Conclusions 17-17

Limitations Of The Study And Possible Extensions 17-17

References 17-17
Appendix 18-19

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 UNEMPLOYMENT RATE AND COMPENSATION   
2002

List of Tables

Title Page

Table 1. Descriptive Statistics 2

Table 2. Least Squares Regressions Results 13

Table 3 ML-ARCH Regressions Results 13

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 UNEMPLOYMENT RATE AND COMPENSATION   
2002

List of Figure

Title Page

Fig:1: Compensation in Canada 3

Fig:2: Compensation in UK 3

Fig:3: Compensation in USA 4

Fig:4: Unemployment in Canada 4

Fig:5: Unemployment in UK 5

Fig:6: Unemployment in USA 5

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 UNEMPLOYMENT RATE AND COMPENSATION   
2002

List of Graph

Title Page

Graph:1: Compensation in Canada 6

Graph :2: Compensation in UK 6

Graph :3: Compensation in USA 7

Graph :4: Unemployment in Canada 7

Graph :5: Unemployment in UK 8

Graph :6: Unemployment in USA 8

Graph :7. Residual, Actual, Fitted 14

Graph: 8. Pooled Result 15

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 UNEMPLOYMENT RATE AND COMPENSATION   
2002

List of Chat

Title Page

Chat:1: Compensation in Canada 9

Chat :2: Compensation in UK 9

Chat :3: Compensation in USA 10

Chat :4: Unemployment in Canada 10

Graph :5: Unemployment in UK 11

Chat :6: Unemployment in USA 11

ix
 Statement of the Problem 

This paper studies the relationship between hourly compensation in manufacturing

and unemployment rate in the United States, Canada and the United Kingdom. Since each
country provides only 20 observations, the parameters from the regression may not be valid.
I further study whether the method of pooling data can be applied to this case by using
dummy variable technique to test the difference of intercepts and slopes in each country.

Literature Review 

In Branson (1989), the compensation should negatively correlated with

unemployment rate because if (inns pay more compensation, labors will have more
incentive to continue working, so unemployment rate is low. But when firms reduce
compensation for labors, unemployment rate will be higher because labors have little
incentive continuing their jobs.

Formulation of General Model: 

The linear regression model is set as follows

Yit = β1+ β2 Xit+ Uit (1)

Where Y;t is civilian unemployment rate, and X; t is manufacturing hourly compensation

in U.S. dollars (index, 1992 = 100). i denotes country-the United States, Canada and
the United Kingdom and t denotes time period. In this case, i = 3 and t = 20.

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 Data Sources and Description 

I used an annual data from 1980 to 1999 of the United States, Canada and the
United Kingdom. There are 20 observations for each country, so 60 observations in total.
The data was from Gujarati 2002 (See Appendix) and its descriptive statistics is presented
in here
Table 1. Descriptive Statistics

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Histogram and Stats

Fig:1: Compensation in Canada

Fig: 2: Compensation in UK

Unemployment Rate and Compensation

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 Fig:3: Compensation in USA

Fig:4: Unemployment in Canada

Unemployment Rate and Compensation

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Fig:5: Unemployment in UK

Fig:6: Unemployment in USA

 
Unemployment Rate and Compensation
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 Graph1. Compensation in Canada

Graph :2: Compensation in UK

Unemployment Rate and Compensation

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 Graph3: Compensation in USA

Graph :4: Unemployment in Canada

Unemployment Rate and Compensation

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 Graph :5: Unemployment in UK

Graph :6: Unemployment in USA

 
Unemployment Rate and Compensation
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 Chat 1. Compensation in Canada

 
Chat :2: Compensation in UK

   
Unemployment Rate and Compensation
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 Chat 3: Compensation in USA

 
Chat :4: Unemployment in Canada

Unemployment Rate and Compensation

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 Chat :5: Unemployment in UK

Chat :6: Unemployment in USA

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 Model Estimation and Hypothesis Testing 

The usual OLS was assigned to estimate equation (1) and 60 observations are
pooled disregarding the space and time dimensions. The results are as follows

Ŷ = 12.439 - 0.053X (2)

Se (0.818) (0.010)

t (15.202) (-5.424)
Rz = 0.3366, d = 0.4806

n=60, df=58

Clearly, compensation is negatively correlated with unemployment rate as

expected and t statistic is statistically significant but R Z value is quite low. Also
Durbin-Watson statistic suggests that perhaps there is autocorrelation in the data. However`,
there are highly restricted assumption in equa t i o n ( 1) because the differences across each
country's data, such as intercept and slope, are not considered. So, the regression results in
(2) may not capture the different characteristics between the cross-sectional unit. If this is to
be the case, maybe each country's data cannot be pooled

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 Table 2. Least Squares Regressions Results  

Table 3 ML-ARCH Regressions Results

One way to take into account the individuality of each country is to let the
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intercept and slope coefficients vary across countries. So the fixed effects model (FEM) is
set by using dummy variables as in equation (3) to test whether the intercepts and slope
Cefficients are statistically different.

Yit = α1+ α2D2i+ α3D3i β Xit+ γ1(D2i Xit)+ γ2(D3i Xit)+ Uit (3)

Where D 2i = 1 if the observation belongs to Canada, 0 otherwise and D3i = 1 if the

observation belongs to the United Kingdom, 0 otherwise. Therefore, the United States is
the comparison country. The results of estimating equation (3) are as follows

Ŷ= 11.524-- 2.181 D2i + 1.029D3i -0.056X;tt + 0.049(D2i Xit) + 0.009(D3i Xit) (4)

se (1.510) (2.173) (1.778) (0.016) (0.025) (0.020)

t (7.627) (-1.004) (0.578) (-3.400) (1.951) (0.463)
R2 = 0.5582, d = O.6764
n = 60, df = 54

As you can see from the model above, all t statistics of the dummy variables added are
not statistically significant at( 0.05) level of significance suggesting that, the intercepts and
slope coefficients of Canada and the/ United Kingdom are not statistically different
from the United States.
Graph :7. Residual, Actual, Fitted

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 If the comparison country is changed, regression model (3) will yield different
results. Let D2i = 1 if the observation belongs to the United States, 0 otherwise and D3i
= I if the observation belongs to the United , 0 otherwise; i.e. Canada is a
Kingdom

Y= 9.342 - 2.181 D2i + 3.211D3 - 0.006X;t- 0.049(D2i Xit) - 0.040(D3i Xit) (5)
se (1.561) (2.173) (1.82 (0.019) ( 0.025) (0.022)
t (5.981) (1.004) (1.76 (-0.341) (-0.463) (-1.758)
R'= 0.5582, d = 0.6764
n = 60, df = 54

Then let D2i = 1 if the observation belongs to the United States, 0 otherwise and D3;
-1 if the observation belongs to Canada, 0 otherwise; i.e. the United Kingdom is a
comparison country, the estimation is as follows

Y= 12.554 – 1.029D2i - 3.211D3i - 0.046Xit - 0.009(D2i Xit t) + 0.040(D3i Xit) (6)

se (0.938) (1.778) (1.822) (0.012) (0.020) (0.022)

t (-0.578) (-1.762) (-3.847) (-0.463) (1.758)
R2 = 0.5582, d = 0.6764
n = 60, df = 54
Graph: 8. Pooled Result

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Fig:7. Pooled Result

All t statistics for dummy variables in both (5) and (6) are statistically insignificant
as in model (4). It can be concluded that the intercepts and slopes of the three countries
are not statistically different suggesting that they can be pooled. However, the R Z value
from model (2) is very low compared with model (4). To do a formal test whether
model (4) is better, F statistic is calculated as follows

(R2UR-R2R)/q (0.5582-0.336)/4
F= = =6.771 (7)
(1-R2UR)/n-k (1-0.5582)/54

Where q is the number of parameter restrictions. The critical value of F with 4 numerator
df and 54 denominator df is 3.16, so F= 6.7713 exceeds the critical value. This proves

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that model (4) can explain the variation in unemployment rate better than model (2),
although coefficients of dummies are statistically insignificant.

Interpretation of the Results and Conclusions 

If we accept that all data sets from the three countries can be pooled and using
regression (2), it can be concluded that if an hourly compensation in manufacturing
increases US$ 1, the unemployment rate will reduce 0.053 percent. But the interpretation
here is subject to some limitations since RZ is very low. However, if we consider model (4)
with higher R 2 value, it would yield similar conclusions except that the unemployment
rate will decrease 0.056 percent when there is a US$1 rise in hourly compensation. This
time, the intercepts and slopes from different country will change, but these coefficients
are statistically insignificant. For example, if there is a US$ 1 increase in compensation,
the unemployment rate will drop 0.056, 0.007 and 0.047 percent in the United States,
Canada and the United Kingdom, respectively.

Limitations of the Study and Possible Extensions 

Since R Z value from the regression (2) is very low suggesting an invalidity of the
model, the assumption that the data from 3 countries can be pooled, which is proved by
FEM, may have to be relaxed. Another method to test whether we can use the panel data
should be considered, for example, use random effects model (REM) or allow all
coefficients vary over individuals as well as time

References: 

Branson, William H. (1989). Macroeconomic Theory and Policy. Third edition,

Harper & Row.

Gujarati, Domadar N. (2002). Basic Econometrics. Fourth edition, McGraw-Hill. p 6

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 Appendix 

Unenrplolvuent rate (UNEM) and hourly compensation in manufacturing (COMP) in the United
States, Canada and the United Kingdom, 1980-1999

Obs UNEM? COMP?

-US-1980 7.100000 55.600000
-US-1981 7.600000 61.100000
-US-1982 9.700000 6700000
-US-1983 9.600000 68.800000
-US-1984 7.500000 71.200000
-US-1985 7.200000 75.100000
-US-1986 700000 78.500000
-US-1987 6.200000 80.700000
-US-1 988 5.500000 8400000
-US-1989 5.300000 86.600000
-US-1990 5.600000 90.800000
-US-1 991 6.800000 95.600000
-US-1992 7.500000 10000000
-US-1993 6.900000 102.700000
-US-1994 6.100000 105.600000
-US-1995 5.600000 107.900000
-US-1996 5.400000 109.300000
-US-1997 4.900000 111.400000
-US-1998 4.500000 117.300000
-US-1 999 4.000000 123.200000
CAN-1980 7.200000 4900000
-CAN-1981 7.300000 54.100000
-CAN-1982 10.60000 59.60000
-CAN-1983 11.500000 63.900000
-CAN-1984 10.900000 64.300000
_CAN-1985 10.200000 63.500000
-CAN-1 986 9.200000 63.300000
-CAN-1 987 8.400000 6800000
-CAN-1988 7.300000 7600000
-CAN-1989 700000 84.100000
-CAN-1 990 7.700000 91.500000
-CAN-1991 9.800000 100.100000

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 -CAN-1992 10.600000 10000000
-CAN-1993 10.700000 95.500000
-CAN-1994 9.400000 91.700000
-CAN-1995 8.500000 93.300000
-CAN-1996 8.700000 93.100000
-CAN-1997 8.200000 94.400000
-CAN-1998 7.500000 90.600000
-CAN-1999 5.700000 91.900000
-UK-1980 7.000000 43.700000
-UK-1981 10.500000 44.100000
-UK-1982 11.300000 42.200000
-UK-1983 11.800000 3900000
-UK-1 984 11.70000 37.200000
_UK-1985 11.200000 3900000
_UK-1986 11.200000 47.800000
_UK-1987 10.300000 60.200000
UK-1988 8.600000 68.300000
UK-1989 7.200000 67.700000
UK-1990 6.900000 81.700000
UK-1991 8.800000 90.500000
UK-19992 10.100000 10000000
UK-1993 10.500000 88.700000
U K-1994 9.700000 92.300000
UK-1995 8.700000 95.900000
UK-1996 8.200000 95.600000
UK-1997 7.000000 103.300000
UK-1998 6.300000 109.800000
UK-1999 6.100000 112.200000

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