The effects of industrial diversification on regional unemployment in Taiwan: is the portfolio theory applicable?

Unemployment issues, particularly recently, have been the subject of heated rhetoric in Taiwan due to the currently high unemployment rate in this small open economy. This paper investigates regional unemployment in 23 counties or cities from 1982 to 2004. Izraeli and Murphy (Ann Reg Sci 37: 1-14, 2003) suggested that the Herfindahl index of industrial structure is positively correlated with the unemployment rate. In this regard, the portfolio theory argues that industrial diversification can only reduce volatility in the regional labor market. In other words, there is a relatively higher regional unemployment rate during periods of economic prosperity and relatively lower unemployment rate during periods of economic slowdown. This view is fully confirmed from the fixed effects model using panel data and the implication is that a comprehensive industrial policy to lower both the unemployment rate and risk in regional labor markets is critical in Taiwan today.