Growth, unemployment, and business cycle integration: Empirical evidence from China

Abstract

This thesis aims to study the macroeconomic performance of China. China has been experiencing rapid economic growth and it has been changing gradually from a planned to a market economy since it initiated the well known “open door policy” combined with a “coastal development strategy” in 1978. However, rapid growth has occurred on the background of increasing regional disparity. Meanwhile, unemployment has increased significantly during last two decades, and has become one of the most pressing problems of the Chinese economy today. Moreover, another major challenge facing the Chinese economy is how to deal with various shocks, and to ensure the sustainability and balance of economic growth in the face of the increasing economic uncertainties associated with its deep reform and integration into the world trade and financial system.

Based on the above concerns and literature review, this study, firstly, uses an augmented Solow-Swan model of Mankiw, Romer and Weil (1992) to assess the role FDI plays in underlying regional differences in economic growth across Chinese provinces over the reform period 1978-2008. My analysis indicates that the augmented Solow growth model appears to provide a good description of regional growth patterns in China over the period 1978-2008 and the data display conditional convergence. After controlling for FDI and other determinants of growth, provinces that were initially poor tend to grow faster and the evidence in favour of conditional convergence becomes even stronger after splitting the data into subsamples.

I then focus on the study of the relationship between unemployment and growth at both national level and regional level in order to find out how unemployment affects China’s economic growth and economic reform progress overall. I find that Okun’s relationship does not hold in China universally and, furthermore, the nature of the observed relationship has changed during the transition progress. I argue that there are hump shaped relationships both between growth and unemployment and between the speed of transition and unemployment in China. The results are consistent with several theoretical and empirical studies in the literature.

Finally, structural VAR methodology pioneered by Bayoumi and Eichengreen (1993) is used to identify and decompose supply and demand shocks to two variables, (the log of) output (annual real GDP) and (the log of) prices (annual GDP deflator). I then compute and discuss the correlation of such shocks across provinces and show how it has evolved over the four main sub-periods of China’s history. Moreover, I investigate which factors contribute to economic integration or divergence in the Chinese economy.