Effects of macroeconomic variables on unemployment in Kenya

Abstract

Unemployment remains a major global challenge, with uneven progress across regions towards the 3% target. In Kenya, despite various interventions since independence, the issue remains unresolved and persistent. The aim of the study was to examine the effects of macroeconomic variables (economic growth, lending rate, development expenditure, and VAT) on unemployment in Kenya and provide empirical insights for designing policies to create employment. The study employed a time series research design to assess how changes in the macroeconomic variables under review influenced unemployment. The study adopted a two-regime Markov switching model with all parameters switching on secondary data for the period 1991-2024. Regime 1 represents a period of stagnating unemployment, while regime 2 represents a period of trend unemployment. The findings established that in both regimes, while economic growth significantly reduced unemployment, development expenditure was found to significantly increase unemployment. Conversely, the lending rate reduced unemployment, but the effect was only significant in regime 2. Similarly, VAT significantly increased unemployment only in regime 2. The findings imply that policymakers should promote sustainable and inclusive growth, while strategically allocating development funds to sectors that are labor-intensive and have high employment potential to create more employment opportunities and reduce unemployment. Additionally, they should enhance access to credit and consider targeted VAT reforms, such as exemptions or reductions of VAT rates, especially during periods of trend unemployment.