Public-sector Employment in an Equilibrium Search and Matching Model

Abstract

In this paper, we extend the standard Diamond-Mortensen-Pissarides model of equilibrium unemployment to incorporate public-sector employment. We modify the model in three ways. First, we assume that workers are heterogeneous in terms of human capital. Second, we assume that productivity is match specic and that the distribution of match-specic productivity is more favorable in the sense of rst-order stochastic dominance the higher is a worker’s human capital. Third, we allow for both private- and public-sector employment. We prove existence of equilibrium and numerically analyze the eects of public-sector employment policy on the distributions of wages, productivities and human capital levels in the two sectors and on overall employment and welfare using data from Colombia.