Government Employment and Wages and Labour Market Performance
| Author | Zenon G. Kontolemis,Dimitri G. Demekas |
| DOI | http://doi.org/10.1111/1468-0084.00177 |
| Date | 01 July 2000 |
| Published date | 01 July 2000 |
GOVERNMENT EMPLOYMENTAND WAGES AND
LABOUR MARKET PERFORMANCEy
Dimitri G. Demekas and Zenon G. Kontolemis
I. INTRODUCTION
The consensus view that has emerged in the literature on the rise and
persistence of unemployment in Europe during the last quarter-century can
be summarized as follows. The rise in unemployment during the 1970s and
1980s was caused by a number of factors, primarily on the demand side
(terms-of-trade shocks, a rising tax burden, and perhaps rising real interest
rates); but also on the supply side (increasing real wage resistance, due in
turn to expanding unemployment bene®ts and greater union militancy). In
addition, once unemployment rose, it persisted at high levels through the
late 1980s and 1990s. This can be attributed to persistence in real wage
aspirations, negative effects of long spells of unemployment on search
intensity and human capital accumulation, extensive employment protection
legislation, capital decumulation in response to high wages, and perhaps
insider membership dynamics.1
This literature has identi®ed the government policies that are behind
many of these factors, notably macroeconomic policies, taxation, unemploy-
ment bene®t and training schemes, and labour market legislation. However,
relatively little attention has been paid to the way the government acts as an
employer, and its direct effect on labour market performance. This re¯ects
the implicit assumption that the government's employment and wage
decisions do not merit separate consideration, either because they are made
OXFORD BULLETIN OF ECONOMICS AND STATISTICS, 62, 3 (2000)
0305-9049
391
#Blackwell Publishers Ltd, 2000. Published by Blackwell Publishers, 108 Cowley Road, Oxford
OX4 1JF,UK and 350 Main Street, Malden, MA 02148, USA.
{When work on this project was started, Kontolemis was a research Fellow at the European
University Institute in Florence. We are grateful to Maria Carkovic, David Coe, Soren Johansen,
Jimmy McHugh, Alessandro Prati, and the participants to a conference on `Unemployment and
Policies Towards It' at the European University Institute in Florence in April 1996 for useful
discussions and comments on various versions of our work. We are especially indebted to Stephen
Nickell and an anonymous referee of the Oxford Bulletin, whose suggestions have greatly
improved our paper. The views expressed in this paper do not necessarily re¯ect those of the
International Monetary Funds.
1The evidence is reviewed in, among others, Newell & Symons (1985), Bean et al. (1986),
Jackman et al. (1990), and Layard et al. (1991). Fitoussi & Phelps (1988) examine the role of
rising real interest rates during the 1980s in a `customer market' pricing model. Alogoskou®s &
Manning (1988a and 1988b) explore the causes of unemployment persistence. Pissarides (1992)
draws attention to the loss of skills during long spells of unemployment. Lazear (1990) and Heylen
(1993) discuss the effect of job security provisions. A thorough survey of the vast literature is
provided in Bean (1994).
on more or less the same grounds as those of private sector employers, or
because they have no particular bearing on overall labour market perform-
ance.
Both of these postulates are questionable. On the one hand, public choice
theory has argued that government actions± and particularly government
employment policy±are dictated by the interests of the bureaucracy and the
need to provide political favours to interest groups (including public sector
unions) in order to stay in of®ce (Niskanen 1971; Buchanan 1977; Courant
et al. 1979); Freeman (1986) has shown that wage determination through
bargaining in the public sector leads to a different outcome than in the
private sector, because of the public sector unions' ability to exploit the
political process;2and in their survey, Ehrenberg & Schwarz (1986)
conclude that `labour market models based upon [...] pro®t maximization
are clearly inappropriate for the government sector'. On the other hand,
there is strong empirical evidence that the size of the government has a
negative impact on overall growth performance (see Barro 1990 and the
references therein), as well as some evidence that it has positive effects on
unemployment persistence (Barro 1988; Layard et al. 1991). Despite this,
there have been few attempts thus far to model explicitly the decision-
making process of the government as an employer and its impact on the
labour market. In this paper, we develop a simple model of the labour
market with endogenous unemployment, in which government and private
sector employers compete for workers but make employment and wage
decisions on the basis of different objective functions; and workers decide
to which sector to seek employment so as to maximize expected utility. This
model allows us to trace the effects of the government's wage and employ-
ment policies on the labour market. We ®nd that government policies aimed
at lowering unemployment may be counterproductive, by in¯uencing wage
and employment decisions of private sector employers and job search
decisions of workers. We then test the predictions of our model empirically
against data from Greece, where the public sector is not only large, but its
signi®cant expansion during the late 1970s and the 1980s went hand-in-
hand with a steady deterioration in labour market performance. The results
suggest strongly that understanding labour markets in countries with a large
public sector, like Greece, requires taking explicitly into account the actions
of the government as an employer.
The following section discusses some stylized facts about the govern-
ment's employment and wage policies that are re¯ected in the design of the
model; section III describes the model; section IV reviews labour market
performance in Greece and reports the results of the empirical tests; and
section V summarizes the conclusions.
2This is different than a situation of wage leadership, which may arise simply as a result of the
government's relative size as an employer.
392 BULLETIN
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