The relationship between the exchange rate and employment in Iran

Transcription

1 International Research Journal of Applied and Basic Sciences 2015 Available online at ISSN X / Vol, 9 (7): Science Explorer Publications The relationship between the exchange rate and employment in Iran Parvaneh Salatin 1, Mahsa Hami 2 1. Assistant professor of Department of Economics, Islamic Azad University Firoozkooh Branch,Firoozkooh, Iran. 2. M.A.Student of Economic of Firoozkooh Branch, Islamic Azad University, Firoozkooh, Iran. Corresponding Author p_salatin@iaufb.ac.ir ABSTRACT:Given the importance of employment in social and economic conditions of different countries, economic policy makers always take into account the employment changes in relation to the macroeconomic variables. Many empirical studies have shown the important effect of exchange rate on employment, and this effect differs depending on the economic and currency system of the countries. Therefore, the main objective of this paper is to examine the impact of the real effective exchange rate on employment in Iran s economy.the results of the model estimation by Ordinary Least Squares (OLS) during ( ) indicated that thereal effective exchange rate has a significant effect on the employment rate in Iran s economy. Key words:employment,real effective exchange rate, Iran. INTRODUCTION With the integration of world economy and the increasing development of international exchanges, all countries could no longer stop ignoring the role of the external sector of the economy in adopting macroeconomic policies. In the international economic system, the link between each country and other countries both in goods market and in property market, is the exchange rate. The growing convergence on capital market after dismantling Bretton Woods Agreement and the huge wave of financial liberalization from the 1980 sonward in developed and developing countries have focused attention on the exchange rate and its fluctuations (Preminger & Frank, 2007). In this regard, exchange rate fluctuations influence economy in different ways. This influence could be in the form of fluctuations in the proportion of tradable goods to nontradable goods, changes in trade balance and alterations in the terms of trade between goods. Therefore, the exchange rate could be considered as the price of property and have significant effects on the supply and demand side of the economy. The exchange rate is also effective in allocation of resources, economic growth, employment and inflation. All of these factors play a key role in the policies of each country (Hau, 2007). Despite the extensive literature on exchange rate and conducted experimental studies on the effect of exchange rate on macroeconomic variables in developing countries, the effect of exchange rate fluctuations on employment has been rarely investigated (Layard & Jakman, 1991). Hence, in this article time series data is used to investigate the way in which the real effective exchange rate fluctuations influence employment rate. Besides, the extent to which this effect is observed and the following hypothesis are explored: There is a significant relationship between the real effective exchange rate fluctuations and employment rate in Iran's economy. The required data collection instruments for this article include the reports and statistics published by information resources of the Central Bank and World Bank. In what follows, after examining the theoretical foundations and Background Research, the model structure used is introduced and estimated and finally conclusions and suggestions are offered. Theoretical Foundations The real effective exchange rate is considered as one of the most important factors in international competitiveness. When the effective rate of the real exchange increases, export competitiveness of the country increases and any decrease in the former decreases the latter one. Therefore, maintaining or improving the real effective exchange rate will have a positive effect on trade balance while decreasing it will have a negative

2 effect. The real effective exchange rate, that measures fluctuations in prices and the relative costs via the common currency, is the most popular index used for competitiveness. The effective exchange rate is a criterion that measures the value for money country against a basket of the money of other countries. This index is the weighted average of the real exchange rate according to a base year. Weights often reflect the relative importance of each one of other countries doing trade with a specific country. Exchange rate is among the most important factors that determine raw material prices, intermediate goods, capital equipment and finished goods. Since fluctuations in exchange rate influence people's expectations, they could also accelerate inflation. Hence, the attention paid by economy experts to close interaction, the importance of fluctuations in exchange rate and inflation in economic stability is of high significance. Economic stability and increase in domestic and foreign investments increase feelings of security and calmness and present a clear picture of economic and social future if the country. This is impossible unless right, timely and fair decisions are made under independent and comprehensive legislative. One completely important and effective factor in exchange rate fluctuations and their effect on the economy is the reducing domestic production at least in the short term. The reason lies in the fact that imports of intermediate and capital goods plays a basic role in the production of developing countries and increases in foreign currency reduces the ability of producers for purchase and consequently they react to the reductions in importing these inputs. In other words, their demand for purchasing foreign currency (imports of capital and intermediate goods) will be decreased. In this way, production function will be affected and consequently fewer outputs will be obtained in the total economy. Reduction of aggregate supply of economy increases inflation and prices and even creates depression and decreases employment. Exchange rate fluctuations lead to unreliability in future prices of goods and services. Economic factors base their decisions about field production, investment and consumption on information provided by the price system. If the prices are unreliable, the quality of the mentioned decisions will be decreased. Fluctuations of exchange rate make the prediction of foreign income of exports difficult for exporters and therefore create problems in marketing, proper planning and specifying export policy. On the one hand, due to the unreliability of rates and risks created by their fluctuations, long-term planning would be impossible and exports activities will be reduced or stopped. On the other hand, these fluctuations will increase the motivation for speculative currency transactions and puts the health of the market in danger. Moreover, this issue mistunes the planning for imports of goods and services that are done via these exports. If structural barriers are absent for expanding exports and other factors are fixed hypothetically and if export profitability increases, the rate of the country's exports should be increased. Principally, fluctuations in exchange rate via unpredictable change made in the prices of imported and exported goods creates barriers in the foreign trade of the country. These fluctuations could influence the foreign trade structurally or have short-term effects and create swing cases in the delivery of exporters. Exchange rate fluctuations have direct effects on the increased problems of workers. These fluctuations change the inflation rate and workers' wage. Given the importance of employment in socioeconomic conditions of different world countries, economic policy-makers always consider employment alterations relative to macroeconomic variables. Many experimental studies indicate that the real exchange rate is one of the effective variables in employment. This effect could be different depending on the kind of the economy of each country and exchange system. Since employment changes are a direct function of production changes, the effect of exchange rate changes on production is indirectly transferred to employment. Background Research Mundaca (2011) in his study titled as, "uncertainty of currency and the optimal participation in international trade," indicates that exchange rate fluctuations increase the uncertainty of participants in international trade. This uncertainty has a negative effect on the international trade and the participants who are involved in it. This condition is really critical especially for countries whose financial derivatives markets of exchange rate are not developed and the costs of covering fluctuations of exchange rate risks are very high. The obtained results indicate that exchange rate fluctuations have inhibitory effects on entrepreneurs involved in exports even when the exports are very profitable. But participants in the international trade may not leave the international trade in the short term even when there is a lack of market profitability. Nucci and Pozzolo (2010) in their study titled as, "currency, employment and time: what do they say at the level of firm's data", investigate the effects of exchange rate fluctuations on employment and the number of working hours of the work force using the data related of China's firms. Via panel data, they indicated that if exchange rate fluctuations change the exports,it will have a positive effect on employment. Firat (2010) in his study titled as, "exchange rate fluctuations and employment growth in developing countries: evidence from Turkey", using the analysis of variance technique indicates that the increase in standard deviation of exchange rate fluctuations reduces the employment growth in the time period of 1983 to

3 Irina Tochitskaya (2008) in his article titled as, "the effect of exchange rate fluctuations on trade balance of Belarus", investigates the relationship between exchange rate fluctuations and trade balance in the short- and long term. The negative effect of exchange rate reduction which is immediately seen is explicable by the lag created so that the consumer and producer will be accustomed to new model buy and also by imbalance between changes in exports and imports. Therefore, adjustment policy based on exchange rate reduction could be considered as a suitable solution for creating balance in foreign trade of Belarus. Hau (2007), in the study entitled as, "the real exchange rate and employment generation in China", investigates the effect of the real exchange rate on employment and its channels by using panel data in 29 counties of China in the time period of 1993 to The real increase in the following factors will have effects on employment (in manufacturing sector): Replacement of workers by imports (technology channel) Reduction in exports (exports channel) Putting pressureon increasing and improving productivity (efficiency improvement channel) The results indicate that there is significant and negative effects of the real increase in Renminbi (China's currency; of course that unit relates to Chinese Vuan) onemployment in manufacturing sector. Among the three channels, the technology channel has a more significant effect. Faria and León-Ledesma (2005) in a study entitled, "the real exchange rate and employment performance in an open economy", investigate the effect of the real exchange rate on employment in England and the U.S. The results of this study show that the real exchange rate has a positive effect on real wages and actual work. Roberto Frenkel (2004) in a study entitled as, "the real exchange rate and employment in Argentina, Mexico, Chili and Brazil", investigates the relationship between the real exchange rate and employment by using the data of Argentina, Brazil, Chili and Mexico related to the time period of 1980 to He concludes that there is a reverse ratio between the real exchange rate and unemployment rate. The increase (reduction) in the real exchange rate involves an increase (reduction) in unemployment. Subrana Samanta (1998) in an article entitled as, "exchange rate fluctuations and foreign trade", has studied the intensity and effectiveness of uncertainty of exchange rate fluctuations on Indian export and import by using the time series data.the obtained results indicate that exchange rate fluctuations have affected the foreign trade only in one case, i.e. the equation of short-term imports. In other equations, there is no effect of exchange rate fluctuations on the components of foreign trade. Nikpoor et. al (2012) in a study entitled as, "the effect of exchange rate fluctuations and direct foreign investment on employment in Iran, and by using an Auto Regressive Distributed Lag (ARDL) model and error correction model (ECM) in the time period of 1974 to 2009 indicate that the reduction in the real exchange rate has a negative and significant effect on employment. A one-percent increase in the real exchange rate reduces employment by percent and increases direct foreign investment. The results also show the asymmetric effects of the real exchange rate fluctuations on employment in Iran. Kazerooni and Asgharpoor (2012) in a study entitled as, "the asymmetric effects of the real exchange rate on economic growth in Iran", indicate Markov and Switching's approach by using time series data in the period of 1973 to Positive shocks in the real exchange rate increase gross domestic production growth and negative shocks reduce gross domestic production growth. The results of asymmetry test indicate that the effect of shocks in the real exchange rate on gross domestic production rate is asymmetric. Karimi et. al (2011) in a study entitled as, "the effects of the real exchange rate fluctuations on employment in Iran", examine the effect of the real exchange rate fluctuations on Iran's employment.they have used auto regressive distributed lag model in the time period of 1974 to 2006.The results of this study indicate a positive and insignificant relationship between the real exchange rate fluctuations and employment. In other words, it could be concluded that in Iran's economy, employment is a function of other economic factors and exchange rate fluctuations little effects on employment. Mehrabi and Javdan (2011) in a study investigated, "the effect of the real exchange rate uncertainty on agriculture sector growth of Iran", in the time period of 1969 to In so doing, Generalized Auto Regressive Conditional Heteroskedasticity (GARCH) pattern was used to index the real exchange rate uncertainty. Also, co-integration auto regression wide lag approach was used to estimate the co-integration relationship and short-term dynamics. According to the results of this study, there are strong and significant short-term and longterm relationships between the variables in the growth model of agriculture sector of Iran. The real exchange rate uncertainty has a negative and significant on agriculture sector growth in the short- and long term. Zamanzade (2010) in a study entitled as, "currency management in Iran's economy" investigated the consequences of currency management. The real exchange rate reduction in the short term through reducing the use of existing production capacity has negative effects. But it has positive effects through increasing new production capacities. In the long term, the real exchange rate reduction via reducing the use of existing capacities and via reducing new production capacities weakens production and local employment. 1196

4 MATERIALS AND METHODS In this article, model (1) is used to investigate the extent to which employment rate is affected by the real effective exchange rate by considering the studies conducted by Mundaca (2011), Nucci and Pozzolo (2010), Firat (2010) and Karimi et. al (2011) and given the effect of different variables on employment. LL. reer 2. reer. LGdp. LTr. Inf. G U (1) t 0 1 t 2 t 3 t 4 t 5 t 6 st t In this equation, LL =employment rate, reer 2 t =the real effective exchange rate fluctuations 1, reer =the effective exchange rate based on the fixed prices of 2005, LGdp =logarithm of the real gross domestic production, LTr = logarithm of tax revenue 2, Inf = inflation rate, G s = government size 3, U =the error of equation and t=time 4. Model (1) Will be estimated by ordinary least squares(ols). RESULTS Before estimating the model, Dickey-Fuller generalized test is used in order to investigate whether variables are static or non-static. Based on the static test and according to table 1, the real effective exchange rate fluctuations, the real effective exchange rate and inflation rate are at the stationary level and other variables are all stationary in the difference between the first. Therefore, the null hypothesis about unit root is rejected. Thus, the stability of the data used in this article is confirmed before estimating the model. In what follows, integration test is used to investigate the long-term relationship between variables. In so doing, Engel-Granger's test can be used to examine integration among variablesin time-series technique. Engel-Granger's test performs the unit root test on the residuals of the model. In this article, the results of Engel-Granger's test strongly reject the null hypothesis on the existence of unit root. It means that the residuals of the model are constant at I o model. This indicates that there is a long-term relationship between the variables of the model. Type of regression Table 1.The study of variables being static or non-static LL reer 2 t reer LGdp LTr Inf Gs Dickey - Fuller Test (P-Value) In Level Dickey - Fuller Test (P-Value) In The difference between the first Result I 1 I 0 I 0 I 1 I 1 I 0 I 1 From EVIEWS Software In table 2, the estimate results of the effect of the real effective exchange rate on employment rate in Iran's economy are given via ordinary least squares. 1. ARCH model is used to examine the real effective exchange rate fluctuations(see Indexes).In this article, other techniques like last year's growth rate and the growth rate of the real effective exchange rate based on the year 1981 were used to calculate the real effective exchange rate fluctuations. Based on the obtained results from the three techniques, the best one to calculate the real effective exchange rate fluctuations is ARCH technique. 2. In Econometrics, logarithm is taken from the bigger variable to indicate the link between two variables when numbers of one of the variables are small and the those of the other are rather bigger compared to the former one so that it could really indicate the link between them. G G 3 s. Government size GDP in which G=government current expenditure and GDP=Gross Domestic Production. 4. It should be noticed that other variables like openness of the economy and virtual variables related to the third oil shock, war and the integrated currency were entered into the model but due to problems in econometrics were excluded from the model. 1197

5 Table 2.the estimate results of the effect of the real effective exchange rate on employment rate in Iran's economy via ordinary least squares Dependent Variable: Employment Rate Variable Variable name coefficient t - Statistics c Intercept reer 2 The real effective exchange rate fluctuations 1.22E reer The real effective exchange rate Logarithm of real GDP LGdp LTr Logarithm of income tax Inf Inflation G Government size s DW Durbin-Watson Statistics R R 2 The coefficient of determination Extended or improved coefficient of determination F From EVIEWS Software The obtained results from the estimate of equation (1) via ordinary least squares indicate the following points: The real effective exchange rate has a negative significant effect on employment rate in Iran's economy. The reduction in the real effective exchange rate via increasing the price of export goods and reducing the price of the imported goods directs the demand for the whole economy toward the demand for foreign goods and services. In fact, exchange rate devaluation reduces the demand for goods produced inside the country both in domestic markets and foreign markets. Reduction in the demand for domestic products leads to partial use of the existing production capacity. Therefore, domestic production via reducing the real effective exchange rate and the non-use of part of production capacity is affected negatively and thus weakens. It is clear that due to reduction in production, employment will also reduce. On the contrary, increase in exchange rate will lead to increase in the demand for domestic products both in domestic market and in foreign market. As a result, the existing production capacities will be fully used and it will have a positive effect on production and employment. Since production in Iran is based on intermediate goods, the increase in exchange rate will lead to the devaluation of national currency. As a result, the costs of imports will be expensive and production incentives will decrease. This in turn reduces employment rate. The real effective exchange rate fluctuations have significant effects on employment rate in Iran's economy. Therefore, the hypothesis related to the significant relationship between the real effective exchange rate and employment rate in Iran's economy could not be rejected. The positive relationship between the real effective exchange rate fluctuations and employment rate obtained from this study is in line with the study done by Karimi et. al (2011). Given the Durbin-Watson Statistics with the value of , the correlation between disturbing elements does not exist. Also, given the in LM test, there is no problem of autocorrelation in the model. 2 The value of the coefficient of determination, R, in the model indicates that more than sixty percent of the changes in employment rate are explained by explanatory variables. CONCLUSIONS AND POLICY RECOMMENDATIONS The obtained results from the estimate of the model via the ordinary least squares technique during indicate that thereal effective exchange rate has a significant effect on employment rate in Iran's economy. Therefore, the hypothesis related to the significant relationship between the real effective exchange rate and employment rate in Iran's economy could not be rejected. Thus, it is suggested that: State budget should be independent of oil income, taxation system should be efficient and the structure of the general budget should be corrected. Given the conducted studies suggesting that exchange rate fluctuations have significant effects on macroeconomic variables, government should adopt suitable fiscal, money and currency policies to control economic fluctuations. The minimum size of government and provision of competition background for other economic sectors (non-governmental organizations) should be taken into account. Government should play supervisory and public security roles and other sectors should have the executive role. 1198

6 A space for the effective presence of the private sector should be created so that its ability could be increased to compete with the public sector. The structure of the prices should be corrected and made efficient. REFERENCES Ahangari A,Basirat M,Nikpoor M. The effect of exchange rate fluctuations and foreign direct investment on employment in Iran.Journal of Engineeringand Applied Sciences.2012; Data from the World Bank to Address : Economic time series data bank & Economic indicators of the Central Bank of the Islamic Republic of Iran to Address : & Faria, J.R. and L.Ledesma. (2005) Real Exchange Rate and Employment Performance in an Open Economy, Research in Economics, 59(1), PP Firat. D. (2010) Exchange Rate Volatility and Employment Growth in Developing Countries: Evidence From turkey, World Development, 38(8), PP Frenkel, R. (2004), Real exchange rate and employment in Argentina, Brazil, Chile and Mexico, Visited at: accessed Hau, P. (2007) Real Exchange Rate and Manufacturing in China, China Economic Review, 18(3), PP Karimi Z,Rasekhi S,Beh Raftar M. The effect on employment of the real exchange rate fluctuations.second National Conference on Student Iranian economy.university of Mazandaran Kazeroni A, Asgharpur H, Mohammadpoor S, Bahari S. The Asymmetric Effects of Real Exchange Rate Fluctuations on the Economic Growth of Iran: Markov Switching Approach.Economic Journal-Address issues and economic policies ; 12 (7 and 8) :5-26 Mehrabi Bashar Abadi H,Javdan E. The effect of uncertainty on the real exchange rate of the agricultural sectorin Iran.Journal of Agricultural Economics.2011;First Year,(3) Mundaka, G, (2011),"Exchange Rate Uncertainty and Optimal Participation in International Trade",The World Bank, Policy Research Working PP Nucci, F. and A.F. Pozzolo, (2010): The Exchange Rate, Employment and hours: What firm-level data say, Journal of International Economics, 82(2), PP Subrana k.samanta."exchange Rate Uncertainty and Foreign Trade for A Developing Country : An Empirical Analysis ", The Indian economic Journal (1998),PP Tochitskaya, Irina, (2008),"The Effect of Exchange rate changes on Belarus Trade Balance", Journal of International Economics,PP. 30, 3 4, Zamanzade H. Exchange rate management in Iran.Monetary and Banking Research Center.New Journal of Economics.2010;Eighth Year,(130). INDEXES Index (1).Calculate the real effective exchange rate fluctuations via Arch Model Dependent Variable: REER Method: ML - ARCH (Marquardt) - Normal distribution Date: 05/02/14 Time: 17:29 Sample (adjusted): Included observations: 30 after adjustments Failure to improve Likelihood after 20 iterations Presample variance: backcast (parameter = 0.7) LOG(GARCH) = C(3) + C(4)*RESID(-1)/@SQRT(GARCH(-1)) + C(5) *LOG(GARCH(-1)) Prob. z-statistic Std. Error Coefficient Variable C AR(1) Variance Equation C(3) C(4) C(5) Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Prob().79 Inverted AR Roots Heteroskedasticity Test: ARCH Prob. F(1,28) Prob. Chi-Square(1) Obs*R-squared Test Equation: Indexes (2).Dickey Fuller unit root tests Null Hypothesis: D(LGDP) has a unit root 1199

7 Lag Length: 1 (Automatic based on SIC, MAXLAG=7) *MacKinnon (1996) one-sided p-values. Null Hypothesis: INF has a unit root Lag Length: 0 (Automatic based on SIC, MAXLAG=7) *MacKinnon (1996) one-sided p-values. - Null Hypothesis: D(LL) has a unit root Lag Length: 0 (Automatic based on SIC, MAXLAG=7) *MacKinnon (1996) one-sided p-values. Null Hypothesis: D(REER) has a unit root Lag Length: 7 (Automatic based on SIC, MAXLAG=7) 1200

8 Null Hypothesis: D(REER2) has a unit root Lag Length: 7 (Automatic based on SIC, MAXLAG=7) Null Hypothesis: D(LTR) has a unit root Lag Length: 0 (Automatic based on SIC, MAXLAG=7) Null Hypothesis: D(GS) has a unit root Lag Length: 5 (Automatic based on SIC, MAXLAG=7) *MacKinnon (1996) one-sided p-values. Null Hypothesis: RESID04 has a unit root 1201

9 Lag Length: 0 (Automatic based on SIC, MAXLAG=6) *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(RESID04) Method: Least Squares Date: 06/05/14 Time: 11:33 Sample (adjusted): Included observations: 28 after adjustments Variable Coefficient Std. Error Prob. RESID04(-1) C R-squared Mean dependent var Adjusted R-squared S.D. dependent var S.E. of regression Akaike info criterion Sum squared resid Schwarz criterion Log likelihood Hannan-Quinn criter Durbin-Watson stat Prob() Index (3). The Estimate of Model via Ordinary Least Squares(OLS) Dependent Variable: LL Method: Least Squares Date: 05/29/14 Time: 22:54 Sample (adjusted): Included observations: 29 after adjustments Prob. Std. Error Coefficient Variable E E C GS LGDP INF LTR REER2 REER Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Prob() Index (4).Heteroskedasticity Test: Breusch-Pagan-Godfrey Heteroskedasticity Test: Breusch-Pagan-Godfrey Prob. F(6,22)

10 Prob. Chi-Square(6) Obs*R-squared Prob. Chi-Square(6) Scaled explained SS Test Equation: Dependent Variable: RESID^2 Method: Least Squares Date: 05/29/14 Time: 23:04 Sample: Included observations: 29 Prob. Std. Error Coefficient Variable C E-05 GS E-05 LGDP E E-07 INF E E-05 LTR E E-09 REER E E-07 REER Mean dependent var R-squared S.D. dependent var Adjusted R-squared Akaike info criterion S.E. of regression Schwarz criterion 6.02E-07 Sum squared resid Hannan-Quinn criter Log likelihood Durbin-Watson stat Prob() Index (5).Correlation LM Test Breusch-Godfrey Serial Correlation LM Test: Prob. F(2,20) Prob. Chi-Square(2) Obs*R-squared Test Equation: Dependent Variable: RESID Method: Least Squares Date: 05/29/14 Time: 23:06 Sample: Included observations: 29 Presample missing value lagged residuals set to zero. Prob. Std. Error Coefficient Variable E E E E C GS LGDP INF LTR REER2 REER RESID(-1) RESID(-2) 3.32E Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Prob() 1203