UNEMPLOYMENT AND PRIMARYCOMMODITY PRICES

Unemployment andPrimary CommodityPricesTheory and Evidence ina Global Perspective

Annalisa CristiniAssociate Professor in EconomicsUniversity ofBergamoItaly

Foreword by Stephen Nickell

First published in Great Britain 1999 by

MACMILLAN PRESS LTDHoundmills, Basing stoke, Hamp shire RG21 6XS and LondonCompanies and repre sentatives throughout the world

A catalogue record for this book is avail able from the Briti sh Library.

ISBN 978-0-333-74833-6

First publi shed in the United State s of America 1999 by

ST. MARTIN'S PRESS, INC.,Scholarly and Reference Divis ion.175 Fifth Avenue. New York . N.Y. 10010

ISBN 978-0-312-22036-5

Library of Congress Cataloging-in-Publication DataCristini, Annalisa, 1961-Unemployment and primary commodity prices: theory and evidence ina global perspective / Annalisa Cristini ; foreword by StephenNickell.p. cm.Includes bibliographical references and index .ISBN 978-0-312-22036-5 (cloth)1. Unemployment---0ECD countries-Mathematical model s. 2. Primarycommodities-Prices-OECD countries-Mathematical model s.3. Petroleum products-Prices-OECD countries-Mathematical models .I. Title.HD5707.5.C753 1999331.13'7---dc21 98-44643

CIP

© Annal isa Cri stini 1999Foreword © Stephen Nickell 1999Softcover reprint of the hartd cover Ist edit ion 1999

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2 I00 99

ISBN 978-1-349-14974-2 ISBN 978-1-349-14972-8 (eBook)DOI 10.1007/978-1-349-14972-8

To Luigi

Contents

List of Tables xi

List of Figures xiii

Acknowledgments xv

Foreword by Steve Nickell xvi

1 Introduction 1

1.1 Modelling the links between primarycommodity prices and the OECD economy 41.1.1 The characteristics of the model and

the bloc approach 5

1.2 Primary commodity prices: a historicalperspective 6

1.3 The oil market 91.3.1 The first oil shock 101.3.2 The second oil shock 121.3.3 The oil market in the 1980s and the

third oil price shock 12

1.4 The relationship between oil and non-oilcommodity prices 14

1.5 The financial markets in the aftermath ofthe oil shocks 15

1.6 DECO activity and primary commodityprices: a vector autoregression analysis 201.6.1 Multivariate Granger-causality tests 221.6.2 Cointegration analysis 29

1.7 Layout of the book 35

Appendix to Chapter 1: import unit value andprimary commodity price index 36

VB

viii Contents

2 The Outline of the Theory 38

2.1 The OECD product market 39

2.2 The functioning of the OECD labour market 40

2.3 Industrial conflicts 42

2.4 The working of the OECD supply side 44

2.5 OECD and LDC aggregate demand 46

2.6 Current account imbalances, the worldcapital market and the real interest rate 47

2.7 The evolution of the LDC external debt 51

2.8 The primary commodity market 52

2.9 The working of the model 552.9.1 The long-run solution 572.9.2 A comparison between the long- and

the short-run 602.9.3 The sources of hysteresis: nominal

inertia 632.9.4 The sources of hysteresis : short-run

factors 65

3 Details of the Model 67

3.1 The OECD production function and priceequation 67

3.2 The OECD labour market 713.2.1 The competitive model 713.2.2 The efficiency wage model 723.2.3 The insider-outsider model 73

3.3 A model of strikes 76

3.4 OECD and LDC aggregate demand 78

3.5 The financial market 79

3.6 The primary commodity market 81

Contents ix

4 Estimations and Simulations 87

4.1 The estimated OECD supply side 87

4.2 OECD and LDC estimated aggregate demand 91

4.3 The estimated financial market 92

4.4 The estimated primary commodity market 94

4.5 How we use the estimated model 95

4.6 The long-run equilibrium 95

4.7 The breakdown of the equilibrium paths 1054.7.1 The economic situation in the five

sub-periods 1074.7.2 Accounting for the change of

equilibrium rate of unemployment 1094.7.3 Accounting for the change of

equilibrium non-oil commodity priceindex 110

4.7.4 Accounting for the change ofequilibrium real wage 110

4.7.5 Accounting for the change ofequilibrium real interest rate 112

4.7.6 Accounting for the change ofequilibrium LDC real external debt 113

4.7.7 Accounting for the change ofequilibrium LDC GDP 114

4.8 The short-run: nominal inertia and thedeterminants of wage and price forecastingerrors 115

4.9 Hysteresis of the OECD unemployment rate 117

4.10 Oil shock simulations 1224.10.1 The role of adjustment processes

and short-run factors 1234.10.2 The role of single external markets

on the OECD economy 129

x Contents

4.10.3 The propagation of the oil shockto the whole system 134

4.10.4 A summary of the oil shock effects 140

Appendix to Chapter 4: the estimated model1958-1988 3SLS 143

5 Conclusions 150

5.1 The descriptive analysis 150

5.2 The vector autoregression analysis 152

5.3 The basic features of the model 152

5.4 External markets and hysteresis of the OECDunemployment rate 153

5.5 What have we learned about the linksbetween primary commodity prices and theOECD economic performance? 1545.5.1 Through which channels do

commodity prices feed into the North? 1555.5.2 Through which channels does the

North economy affect externalmarkets? 155

5.5.3 What is the role of the financialmarket? 156

5.6 How does the system react to exogenousprimary commodity price shocks? 156

5.7 The impact of the real price of oil on thelow-frequency movements of the endogenousvariables 157

5.8 Epilogue 159

Data Appendix: Definitions and Sources 160

Notes 164

References 173

Index 179

List of Tables

1.1 Export composition: share of goods in totalexports 7

1.2 Standard deviations of commodity prices andof the OECD GDP deflator 8

1.3 Capital formation, domestic savings andInternational capital transfers 18

1.4 Total resource flows to different categories ofdeveloping countries , 1981 19

1.5 Unit root tests 1958-88 221.6 X2(2) test for the significance of the primary

commodity price index in the rate ofunemployment equation 23

1.7 X2(2) test for the significance of the rate ofunemployment in the primary commodityprice equation 24

1.8 X2(2) test for the significance of OECD GDPin the primary commodity price equation 25

1.9 X2(2) test for the significance of OECD rateof unemployment in the primary commodityprice equation 25

1.10 X2(2) test for the significance of the realinterest rate in the rate of unemploymentequation 26

1.11 X2(2) test for the significance of rate ofunemployment in the real interest rateequation 26

1.12 X2(2) test for the significance of theshort-term nominal interest rate in theprimary commodity price equation 27

1.13 X2(2) test for the significance of the primarycommodity price index in the short-termnominal interest rate equation 28

1.14 Johansen cointegration tests 31

Xl

xii List of Tables

1.15 Estimated cointegrated vectors in Johansenestimation (normalized) 33

1.16 Estimated cointegrated vectors in Johansenprocedure (normalized) 34

4.1 Long-run equilibrium estimated equations 1054.2 Changes of endogenous and exogenous

variables by sub-periods 1064.3 Breakdown of the change of equilibrium

OECD unemployment rate (percentage points) 1094.4 Breakdown of the change of equilibrium real

non-oil primary commodity price (percentage) 1114.5 Breakdown of the change of equilibrium real

wage (percentage) 1124.6 Breakdown of the change of equilibrium real

interest rate (percentage points) 1134.7 Breakdown of the change of equilibrium real

LDC external debt (percentage) 1144.8 Breakdown of the change of equilibrium real

LDC GDP (percentage) 1154.9 Breakdown of wage and price forecasting

errors (percentage) 1164.10 The persistence of U 1184.11 The effect of the primary commodity market

on the persistence of U: financial marketexogenous 120

4.12 The effect of the financial market on thepersistence of U: primary commodity marketexogenous 121

5.1 Changes of the oil price and of someequilibrium variables due to the price of oil(percentage) 158

List of Figures

1.1 DECD rate of unemployment and primarycommodity prices 1

1.2 Rate of unemployment and non-oil commodityprices 2

1.3 Rate of unemployment and the price of oil 21.4 Rate of unemployment and real non-oil

commodity prices 31.5 Rate of unemployment and the real oil price 31.6 Non-oil primary commodity price indices 141.7 Industrialized countries: imports by origin 161.8 Non-oil developing countries: imports by

origin 161.9 Real interest rate and highly indebted

countries import volume 202.1 Number of industrial conflicts in the DECD 432.2 North equilibrium 452.3 DECD real rate of interest 492.4 North-South equilibrium 592.5 Short- and long-run lines 622.6 Constant change of inflation line 644.1 Wage and price lines 964.2 Production function and aggregate demand 964.3 North and South lines 974.4 DECD rate of unemployment 994.5 Real wage 994.6 Real interest rate 1004.7a Real non-oil primary commodity price 1004.Th Nominal non-oil primary commodity price 1014.8a Real LDC external debt 1014.8b Nominal LDC external debt 1024.9a Normalized number of conflicts 1024.9b Number of conflicts 1034.10 DECD GDP 1034.11 LDCGDP 104

Xlll

xiv List of Figures

4.12 Recursive estimates of the coefficient oflagged U 119

4.13 Recursive estimates of the coefficient of U* 1194.14 Recursive estimates of the coefficient of

lagged U. Restricted model: North +primary commodity + LDC GDP 121

4.15 Recursive estimates of the coefficient oflagged U. Restricted model : North +financial market 122

4.16 Rate of unemployment multipliers 1244.17 OECD GDP multipliers 1244.18 Real wage multipliers 1254.19 Normalized number of conflicts multipliers 1254.20 Real non-oil primary commodity price

multipliers 1264.21 Real interest rate multipliers 1264.22 LDC GDP multipliers 1274.23 LDC real external debt multiplier 1274.24 The restricted models 1294.25 Rate of unemployment dynamic multipliers 1304.26 OECD GDP dynamic multipliers 1314.27 OECD inflation dynamic multipliers 1324.28 Real wage dynamic multipliers 1334.29 Normalized number of conflict dynamic

multipliers 1334.30 Rate of unemployment sequential multipliers 1354.31 OECD GDP sequential multipliers 1354.32 Real wage sequential multipliers 1364.33 Normalized number of conflict sequential

multipliers 1374.34 OECD inflation sequential multipliers 1374.35 Non-oil primary commodity price sequential

multipliers 1384.36 Real interest rate sequential multipliers 1394.37 LDC GDP sequential multipliers 1404.38 LDC real external debt sequential multiplier 141

Acknowledgments

This book ensues from my Oxford DPhil thesis which I wroteunder the supervision of Professor Stephen Nickell. Althoughthe basic ideas developed in the thesis remain , this book is theresult of further efforts: overall the topic has been investigatedin greater detail , a description of the facts has been providedtogether with more extensive statistics; the theoretical modelitself has been revised and the empirical analysis updated.

My most generous thanks go to Stephen Nickell. I learned alot from him as a student and afterwards; tenaciously he keptreading the numerous drafts of the book and always gave mestimulating advices and sharp comments.

I also wish to thank Piero Ferri who has been the supervisorof my undergraduate thesis at the University of Bergamo; henever stopped encouraging me to complete this work.

I am also obliged to Richard Layard, Edmund Phelps,Robert Bacon and Christopher Gilbert, for interesting discus­sions and stimulating ideas; to David Vines and Andrew Glyn,who had been the external examiners of my DPhil thesis; toDaphne Nicolitsas, who read a draft of the manuscript.

Finally, this book has also improved from the comments oftwo anonymous referees who suggested important revisions onan earlier draft .

xv

Foreword

This book is based on an Oxford DPhil thesis which Isupervised and which was completed in the late 1980s.

The idea is to explain unemployment across the OECD,treating the DECD countries as one unit. Such aggregationwill, of course, lose some of the fine detail but there aresignificant gains. Over the last three decades, there have beendramatic fluctuations in unemployment in all the DECDcountries, with unemployment being substantially higher todaythan it was 30 years ago in all of them. Furthermore, thefluctuations themselves are highly correlated. As a conse­quence it is commonplace to find that explanations ofunemployment in anyone country depend, at least in part,on the level of economic activity in the rest of the world. In theearly 1980s, the 'world recession' was blamed for the thenparlous state of more or less every DECD economy.

But this is hardly a deep explanation because , once we addup all the countries, it is no explanation at all. The fundamentalproblem is, what caused the world recession in the first place?And this is best answered by analysing the world.

We can start with a simple fact. The correlation between theDECD unemployment rate and primary commodity pricesover the period 1954-91 is 0.94. This is extraordinarily high andis not just the result of both series being simple trends. So thesuggestion must be that primary commodity prices are part ofthe story.

This led to an initial investigation of the DECD bloc,treating primary commodity prices as exogenous. This turnedout not to be good enough, because the obvious feedback fromDECD activity to commodity prices was too large to beignored. So the next strategy was to split commodity prices intooil and non-oil, taking only the former as exogenous. Here theground is a bit firmer because many of the major fluctuations inthe oil price are driven by forces other than DECD economicactivity. However, the need to explain non-oil commodity

xvi

Foreword XVII

prices leads inexorably to a more detailed analysis of the non­OECD bloc, and the inclusion of key factors such as non­OECD debt and world real interest rates.

The model set out in what follows is about as far as it ispossible to go while retaining the ability to see what is going on.It is, perhaps, a shade complicated but it repays study andproduces many insights. To find out more, read on!

Stephen NickellUniversity of Oxford