Government Employment and Wages and Labour Market Performance

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.