Government Employment and Wages and Labour Market Performance

Abstract

Government wage, benefit, and employment decisions are not taken on a profit‐maximizing basis, and have a substantial impact on aggregate labour market performance and unemployment. In a two‐sector labour market model with free mobility of labour, an increase in government wages or benefits reduces private sector employment, and government employment is not an effective counter‐cyclical instrument. Empirical tests for Greece confirm that the expansion of the public sector in the 1980s contributed to the deterioration of labour market performance.