ISSN 2039-2117 (online) ISSN 2039-9340 (print) Mediterranean Journal of Social Sciences MCSER Publishing, Rome-Italy Vol 5 No 20 September 2014 79 Economic Growth - Unemployment Nexus in South Africa: VECM Approach Oatlhotse Madﾖto University of South Africa, Department of Economics Email: opmadito@yahoo.com John Khumalo Department of Economics, University of South Africa, South Africa P.O. Box 392, UNISA 0003, South Africa Email: khumamj@unisa.ac.za Doi:10.5901/mjss.2014.v5n20p79 Abstract This study analyses unemployment – economic growth relationships and tests for any long-run relationship for the period 1967Q1 to 2013Q4. Due to the dynamic nature of the inter-relationships, the error correction is performed in order to find the speed at which growth of gdp adjusts to shocks in employment/unemployment in South Africa. The quality properties of data used reveal that such data does not contain correlation and hence the variables are integrated of order zero. The Johansen cointegration test revealed about four cointegrating vectors, while the model identification showed the South African growth model can be uniquely identified. This was done by imposing restrictions on the estimated coefficients. The vector error correction (VECM) method was used to test for short-run dynamics and the results showed that about 62 percent of economic growth is corrected each quarter. These overall results show that there is a negative relationship between economic growth and unemployment in South Africa. Keywords: Economic growth, Unemployment, VECM, South Africa 1. Introduction Unemployment and slow growth continues to be two of the major challenges facing every country regardless of the state of their economic and social development. The rate of unemployment has been relatively high at least since the 1980s, on the other hand the periods of unsteady growth has also been identified as the major driver that led to an increase in the rate of unemployment over the years. While the level of unemployment affects the rate of GDP-Growth, it also serves as an indicator of the country’s state of the economy as it indicate how well the economy utilizes its resources. Vast of literature exist on the relationship between GDP-growth and unemployment; however, various economists and policy makers still have contradictory views on the significance and the direction of the relationship. South Africa faces a number of challenges with respect to effective and sustainable economic growth since the extent to which economic growth exists is mainly determined by changes in employment, output, inflation, interest rates and other macroeconomic variables that have an indirect impact on GDP such as disposal income and household expenditure. The problem of high unemployment and slow growth is not only faced by developing countries. At some point, developed countries have also been subject to the two fundamental macroeconomic problems. As indicated by Abel et al (2008) the difference between developed nations and developing nations is that developed nations have at some point in their history experienced extended periods of rapid economic growth but that the poorer nations either have never experienced sustained growth or have had periods of growth offset by periods of economic decline. The relationship between economic growth and unemployment is different from that of economic growth and employment which is positively related. In other words it is assumed that an increase in gross domestic product (GDP) or economic growth leads to a decrease in the rate of unemployment. Contrary to unemployment, an increase in GDP- growth leads to an increase in the level of employment indicating a positive relation between GDP-growth and employment. However, assuming a direct link between economic growth and unemployment is not necessarily correct in reality based on the assertion that employment will rise only if economic growth rates exceed productivity gains (potential output). Expressed differently, in the long run the unemployment rate will only fall if GDP growth exceeds the combined growth rates of the labor force and productivity (Levine, 2013).