Towards a theory of the labor market with a public sector

The object is to specify and analyze equilibrium in a labor market with frictions when there is a significant public sector. In the vast majority of equilibrium studies on labor markets, a public sector has been ruled out by assumption. This seems a strange oversight as about 17% of workers in the US are public sector workers, whereas in western Europe, approximately 22% of workers work in the public sector. The goal in this study is to provide answers to such questions as: what happens to private sector wages if the public sector is increased? If the Government increases the number of public sector jobs, does this crowd out private sector jobs? When will private sector wages be greater (less) than the public sector wage? Reasonably complete answers to these questions (and others) are provided within the context of the model developed.

► A labor market model is constructed where there is a significant public sector.
► Given the public sector wage and its size, a labor market equilibrium exists.
► In equilibrium there is a non-degenerate distribution of private sector wages.
► Private sector firms may offer a wage more or less than the public sector wage.
► The public sector may be able to reduce it costs by offering a higher wage.