Public Sector Size and Local Labour Responses in a Transition Economy

2013–2014

ERSTE Foundation Fellowship for Social Research Labour Market and Employment in Central and Eastern Europe

Public Sector Size and Local Labour Responses in a Transition Economy Jelena Nikolic Vassilis Monastiriotis

PUBLIC SECTOR SIZE AND LOCAL LABOUR RESPONSES IN A TRANSITION ECONOMY1

Jelena Nikolic j.lausev@lse.ac.uk Visiting Research Fellow at the European Institute London School of Economics (LSE) Research on South Eastern Europe and Vassilis Monastiriotis Associate Professor at the European Institute London School of Economics (LSE) v.monastiriotis@lse.ac.uk

Postal Address: European Institute and Hellenic Observatory London School of Economics London WC2A 2AE, UK

Abstract The paper uses individual-level data from Serbia as transitioning economy to estimate public sector size effect on individual private sector wages net of worker and job characteristics.

Two alternative measures of public sector size are constructed at two geographical scales.

The paper finds that public sector influences local labour markets more by its relative weight in pecuniary terms than by its employment size. The estimates are positive albeit non-linear and stronger in models estimated at wider spatial scales. Results obtained in this paper suggest possible significant adverse effects, due to recent public sector austerity measures, through downward pressures on private sector wages and thus on total labour incomes in the economy.

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This research project is financially supported by ERSTE Foundation Fellowship for Social Research

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Public sector size and local labour responses in a transition economy 1. Introduction In recent years there has been an upsurge in academic and policy interest on the relationship between public sector employment and private sector jobs. This has followed partly from policy developments related to public sector downsizing and cuts (e.g. as a response to the fiscal crisis in the Eurozone). However, studies that looked at the direct impact of public sector size on local labour markets are still scarce. This paper aims to investigate how changes in public sector size affected local economy in transitioning countries by using Serbia as a particular case at hand.

Transitioning countries are countries that downsized formerly dominant public sector through large scales privatisations. Although these countries achieved a transfer from communist to market system there is still a substantial influence of the public sector on local economy.

In particular case of Serbia, although the public sector share in employment has been reduced significantly during the mature period of transition,"from 43 per cent in 2004 to 35 per cent in 2007, it is still unambiguously large2. Furthermore, in the same period the public sector average wage premium has been increasing, from close to zero in 2004 to 19 per cent in 20073 (Nikolic, 2014). The size of the public sector and increasing public sector wage premium raise concerns about workers’ flow efficiency between sectors.

This paper attempts to reveal effects of both size of the public sector employment and the level of public sector wages on private sector wages. These effects are expected to vary predominantly across regions given the differences in pace of public sector restructuring, speed of privatisation and other region-specific factors (Arandarenko and Nojković, 2007).

For this reason, the paper presents effects at the local level estimated at two geographical scales: municipality and district level. The paper uses micro-data from Serbia in the major period of economic transition just before the global recession, i.e. from 2004 until 2007. We rely on an extended Mincerian wage equation, specified at the individual level to which various controls for the impact of the public sector are added.

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The public-sector wage bill constituted one quarter of total public expenditures and nearly one-tenth of GDP.

3

for full time male employees after controlling for observables

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The paper finds important results. Firstly, there is a positive albeit non-linear relationship between public sector size and individual private sector wages at local labour markets.

Secondly, at the municipality level local private sector wages are not in effect influenced by the size of the public sector employment but rather by the relative weight that this has, in pecuniary terms, to the local economy. Thirdly, the estimates appear stronger in models estimated at wider spatial scales. Perhaps surprisingly, these results imply that recent austerity measures in the public sector in terms of both employment and wage reductions may adversely effect local labour markets conditions via downward pressures on private sector wages. The paper is organised as follows. First section reviews international literature. The second part explains research strategy and data. The following part presents the empirical results. The final part concludes the paper with some policy implications.

2. Literature review Micro-economic research on correlation between public and private sector jobs is surprisingly lacking in the international literature, with only a handful of macro-level studies examining this relationship.4 Following search/matching tradition in recent theoretical models, crowding out occurs not through a public-sector effect on capital (or wage) costs but through its effect on hiring (and job-search) probabilities in the private sector (Albrecht et al., 2011, Bradley et al., 2012 and Burdett, 2012). Burdett (2012) exemplifies best this new approach to the public-private employment question: in his model, public sector jobs crowd out private sectors jobs in a one-to-one basis as long as public sector wages are not below the distribution of wages offered in the private sector.

However, empirical studies estimating the overall impact of longer term growth of public sector size in terms of both employment and wages are scarce. Algan et al. (2002) finds at the macro-level that public sector crowds out total employment if public sector wages are high and/or when goods produced by the two sectors are substitutes. The public-private spill-over effects may also emerge when size of the public sector employment and/or the level of wages are used as a redistributive method for development of lagging regions within a country (as discussed in Alesina et al., 1999). In this context, Overman and Faggio (2014) consider interactions between public and private employment at the local level in England using a """""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 4

For example, theoretical studies such as Holmlund and LindĂŠn (1993), HĂśrner et al. (2007), Quadrini and Trigari (2008), Gomez (2010), examine macroeconomic effects of public sector on labour market performance."

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micro-economic approach. This study finds that each additional public sector job in England creates 0.5 jobs in non-tradable sector but crowds out 0.4 jobs in the tradable sector.

Furthermore, there are even fewer micro-level studies that focus on worker type rather than on industry sector. For example, Lacroix and Dussault (1984) use data on Canadian wage agreements to show the presence of public-private wage spill-overs when white or blue collar public sector workers are in the same urban area as private sector workers. This effect is found to be stronger if the labour market tightness is larger and weaker if the urban area of the private sector is smaller and if foreign competition is greater. Jacobsen (1992) investigates effects of government employment on wages. This study finds positive effect of government employment (measured as proportion of each occupation) on private sector wages in the US but also points to strong nonlinear patterns. Finally, following similar methodology, Telegdy (2014) measures wage spill-overs from public to corporate sector due to large public sector wage increase between 2001 and 2002 in Hungary. The estimates are obtained within gender-experience-occupation worker type. Results from this study indicate that a 10 per cent higher share of public sector workers within labour market segment caused almost equivalent percentage increase in corporate wage growth around the wage increase when controlling for firm, labour market segment, and worker-firm fixed effects.

In this paper we are interested in effects of public sector size on local labour markets. For that reason we estimate public sector size effect on individual private sector wages within each worker job municipality and district location. Our research strategy and individual level data used in our empirical analysis are explained in a following section.

3. Research questions, data and empirical strategy As indicated previously, our analysis in this paper seeks to examine the local labour market responses to changes (over time) and differences (across space) in the size of the public sector. Recent contributions in the literature seeking to address this question have focused on the (un)employment effects of the public sector (e.g., Overman and Faggio, 2014).

In this paper we focus instead on the (private-sector) wages, as a more immediate proxy for the equilibrium effects of the public sector on the private segment of the economy. The rationale for this is that any public-sector-induced changes in labour demand and supply in the private economy may be offset by equilibrating movements in private sector wages – in ways that may then under-represent the overall impact of the public sector there.

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Additionally, the public sector (with its traditionally above-market-clearing wages and compressed wage distributions) may be affecting directly market wages in the private sector, even in the absence of any employment effects (e.g., through shadowing of wage-bargaining in the absence of perfectly competitive markets).

To estimate the private-sector wage effects of public sector size (henceforth, ‘public sector wage effects’) we follow a research strategy that has been increasingly used in applied research in recent years – and in particular in studies seeking to examine area-level spillover effects on individual-level outcomes. Specifically, we make use of a framework of Mincerian wage equations (estimated at the individual level), to which we add an environmental variable proxying for the weight of the public sector in each local economy. This is an approach similar to that employed by Moretti (2004) and others, seeking to identify area-level effects (e.g., share of professionals or highly-educated workers) on individual outcomes (in particular, wages).

We use two complementary measures for the weight/size of the public sector. One, following the recent literature, is simply the share of public sector employment in the local labour market: this proxies more directly the extent of competition between the two sectors (public – private) for a (presumed quasi-fixed) supply of available labour. The second measure is the public sector share of the total wage incomes generated in each local economy – measuring the size of the public sector not in ‘headcount’ terms but in terms of relative purchasing power generated in each sector. The use of these complementary measures allows us to examine whether the impact of the public sector on the private economy is driven predominantly by demand/supply movements or, rather, operates through product demand.

As we discuss below, there is an important element in this distinction.

Theoretically, the private sector may impact on the private economy via a number of channels. First, (rising) public sector employment may induce a negative supply effect in the private sector, thus raising equilibrium wages there – as more workers are absorbed away from the available labour pool. It may also have an indirect negative labour-demand effect (with the opposite result, i.e., lowering equilibrium wages), via a process whereby (expansions in) public sector activity raise production costs in the private sector thus reducing labour demand there.5 Inversely, higher shares of public sector employment may lead to """""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 5

At the national (closed economy) level, this is usually conceptualised as an effect operating via borrowing costs: as public sector expansion is financed through deficits, borrowing costs rise for private firms leading to a

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higher (and less cyclical) levels of private consumption in the economy, thus also stimulating private sector labour-demand.6 Moreover, the public sector may have a direct positive demand effect through its own demand for goods and services produced privately. Such mechanisms will tend to increase equilibrium wages in the private sector – importantly, without having a negative impact on levels of employment there. On the other hand – although somewhat less likely – the public sector may also induce a positive supply shift in the private economy (thus depressing equilibrium wages): to the extent that active job search (or employment) in the private segment of the economy represents a positive signal for hiring in the public sector, the presence of a large (and better-paying) public sector will help push ‘discouraged workers’ away from inactivity. Finally, as noted previously, the public sector may also have a direct effect on private sector wages (i.e., without prior changes to demand or supply in the private sector), through wage-bargaining spillovers in the case of non-competitive wage determination (e.g., private sector unions).

Our use of the two complementary measures of public sector size (employment share and wage-bill share) allows us shed some light on the relative weight of these mechanisms. As an example, assume that the public sector wage effect is estimated to be negative. If the estimated effect is smaller when the public sector is measured in ‘wage-bill’ rather than ‘headcount’ terms, this could be taken as an indication that wage-push, consumption and ‘income’ effects are also in operation (all tending to push private sector wages up). If instead the (negative) wage effect becomes stronger when measured in ‘wage-bill’ terms, this would seem to suggest the presence of an ‘activation’ mechanism, whereby higher relative incomes in public sector incentivise workers to increase their attachment to the labour market.

In addition to this research strategy, we also explore the mechanisms driving the relationship between public sector size and private sector wages via two other means. First, by looking at variations in the intensity of this relationship at different spatial scales – specifically at the

""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" leftward shift in labour demand. At the local (open economy) level the mechanism may operate more via rises in fixed production costs related to production inputs that are in relatively fixed / inelastic supply (e.g., office space).

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Note that this effect can be activated even in the absence of public-sector wage premia: owing to the higher job-stability and job-security afforded by public sector employees, precautionary savings can be expected to be, ceteris paribus, lower resulting in a higher marginal propensity to consume for public sector employees. Of course, the presence of a public sector premium will act to strengthen this positive demand effect.""

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municipal and district levels.7 We expect that demand effects (rising costs or rising consumption) will operate more locally, and thus will be stronger at the municipal level, whereas supply effects (especially those relating to negative supply shocks, i.e., viewing the public-private allocation of employment as a zero-sum game) should be stronger at wider spatial scales (i.e., at the district level).8 Second, we examine the presence of non-linearities in the relationship under investigation: by doing so, we allow for competing mechanisms (e.g., crowding out, leading to reduced labour demand and thus to lower wages; and competition for labour, leading to reduced labour supply and thus to higher wages) to operate simultaneously but to kick-in at different levels of public sector employment (and/or wagebill shares).

As already stated, in our approach we utilise a Mincerian wage equations framework, whereby individual wages are a function of a (parsimonious) set of individual characteristics (gender, education, labour market experience and its square, and marital status) and job characteristics (occupations) plus an environmental variable measuring the size of the public sector in the local economy. We implement this using data from the Serbian Labour Force Survey (LFS) for the years 2004-2007.9 Our LFS data are based on a nationally representative random sample derived from a two-staged stratified sampling method. There are about 6,500 households in each survey, with a total number of interviewed individuals around 20,000 per year. Each of the annual data sets represents a cross-sectional view of the labour market.

The working samples are restricted to full-time male and female employees in the private sector between 15 and 64 years who reported non-zero monthly wages and non-zero hours of work for their main job only. As discussed, each employee has been assigned two measures of the public sector size calculated at the municipal and district level according to his/her job location. The first measure is the public sector share of total employment while the second measure is the public sector wage bill share in local economy (i.e. at the municipal or at the """""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 7

Serbia is administratively split into 145 municipalities distributed across 24 districts.

8

This is because commuters account for a smaller share of employment at wider spatial scales – the district level – as the biggest share of commuting nationally is across municipalities of the same district (within-district commuting).

9

Micro-data from Serbian Labour Force Survey (LFS) during the period covered in our paper were collected annually in October. Our timeframe is limited by two factors. Pre-2004, by the consistency of variable definitions (wages, occupations and the public sector indicator). Post-2007, by the eruption of the global financial crisis, which has resulted in an asymmetric shock between the public and private sectors.

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district level). The public sector is defined to include public administration, education and health and public enterprises.

The earnings definition relates to pay received for the reference month excluding taxes, pensions, and any welfare payments, and any arrears owed to the worker may be reflected in the monthly pay measure. The hourly pay is calculated by dividing the last month’s pay by monthly working hours, obtained by multiplying the reported usual numbers of hours worked per week by the average number of weeks in a month (i.e., 4.25). The hourly pay is deflated by the consumer price index (CPI) using October 2005 as the base.

Based on this dataset, our estimating model takes the following form: (1) where ln(hw) is the natural logarithm of hourly wages, x is a vector of individual characteristics, P is a person-invariant measure of the size of the public sector (varying by year and location) and ε is a case-specific disturbance.

As is well known, Mincerian models of wage determination suffer from potential endogeneity, predominantly because some acquired worker characteristics (e.g., education) cannot be said to be exogenous to the outcome variable (wages).10 Although this is not a real concern in our analysis (as long as our variable P is not correlated with unobserved worker characteristics, omitted variable bias may come into our estimates of the β coefficients but will not affect our estimate of γ), a problem of endogeneity (in the form of inverse causality) may well arise in equation (1) if the public sector share is not independent of the level of ‘net’ wages observed in each region/year. As has been shown in the international literature (Alesina et al., 1999), public sector employment often serves a redistributive function, concentrating disproportionately in areas of weak labour demand and low wages. To the extent that this is true also in our sample, estimating equation (1) by OLS will tend to produce more negative estimates of γ, conflating between the direct (‘causal’) public sector effect (which may well be positive) and the ‘selection’ (inverse causality) effect of wages on public sector employment (which is assumed to be negative).

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Typically, this is theorised as an issue of omitted variable bias (and simultaneity), whereby unobserved ability affects both the observed wage and the level of education (past education decisions), resulting in inflated estimates of the education effect in equation (1).

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To deal with this problem we extend our analysis in two ways. First, we amend the model of equation (1) to include a full set of area (and time) fixed effects. To the extent that selection of the public sector into particular (types of) areas is constant over time11, the inclusion of the fixed effects will capture entirely this selection influence, rendering the OLS (fixed effects) estimates unbiased. Thus, our estimation model becomes: (2) with dr (dt) representing now a vector of area-specific (year-specific) fixed effects.

As noted, we estimate the model in equation (2) using two alternative measures of public sector size (employment share and share to wage-bill) and at two geographical scales (municipalities and districts), also examining in cases the presence of non-linearities (by extending the model to include quadratic terms of the public sector variable). The next section presents and discusses the results of this analysis.

4. Empirical Results We start our analysis by using individual-level data in Mincerian wage regression, as presented in previous section in equation (1). Subsequently, we expand Mincerian wage regression to equation (2) by adding area-specific (year-specific) fixed effects. As explained previously we follow largely the approach developed by Moretti (2004) and the related literature on education spill-overs on wages. Our micro-econometric approach is also similar to the approach followed in the Wage Curve literature (where individual net wages are regressed on area-wide unemployment). Moreover, by looking at individual net wages (net of characteristics) we avoid having our estimated public sector effect being influenced by the composition of skills etc. in the workforce; which would be a problem if the public sector had either a 'cream off' effect (reducing the available supply of skills in the private sector) or a 'skill upgrading' effect (attracting in the region workers with higher skills).

Our research strategy is applied at two spatial scales: municipality and district levels. Table 1 presents results obtained at the municipality level. Starting from results presented in first column in Table 1, public sector employment appears to correlate positively with private sector wages at the local level. Assuming, for the sake of argument, full exogeneity and no

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Note that this assumption becomes more realistic given our short (four-year) timeframe.

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inverse causality, this could be taken to signal that public sector presence is linked to upward pressures on wages in the local economy.

As noted earlier, however, this could be consistent with a number of underlying mechanisms.

For example, an adverse effect on labour supply (labour competition effect), a positive effect on product demand (income effect), or simply a direct wage spillover through wage bargaining. In any case, the result does not seem to support a simple ‘crowding out’ hypothesis (negative labour demand effect), whereby the presence of the public sector crowds out private-sector employment (which should then be associated to lower wages).

Table 1: Effect of Public Sector Size on Private Sector Wages at the Municipality Level Employment" share" "

Employment" share" "

Employment" share"

WageCbill" share"

WageCbill" share"

Variables:"

Employment" share" "

"

"

"

Experience"

0.016***"

0.014***"

0.012***"

0.012***"

0.012***"

0.012***"

"

(0.002)"

(0.002)"

(0.002)"

(0.002)"

(0.002)"

(0.002)"

Experience"Sq."

C0.028***"

C0.026***"

C0.023***"

C0.023***"

C0.023***"

C0.023***"

"

(0.006)"

(0.005)"

(0.005)"

(0.005)"

(0.005)"

(0.005)"

Public"Sector"

0.402***"

0.553***"

0.097"

0.545"

C0.0102"

0.744**"

"

(0.143)"

(0.149)"

(0.085)"

(0.331)"

(0.071)"

(0.328)"

Public"Sector"squared"

"

"

"

C59.42"

"

C0.767**"

"

"

"

"

(44.48)"

"

(0.329)"

Constant"

3.636***"

3.476***"

3.941***"

3.870***"

4.003***"

3.835***"

"

(0.052)"

(0.080)"

(0.069)"

(0.083)"

(0.067)"

(0.097)"

Observations"

7,615"

7,615"

7,615"

Fixed"effects"

No"

Year"

Year"and"Area"

7,615" Year"and" Area"

7,615" Year"and" Area"

7,615" Year"and" Area"

RCsquared"

0.288"

0.312"

0.407"

0.408"

0.407"

0.408"

Public"defined"as:"

Notes to Table 1: All regressions include controls for personal characteristics (gender, marital status, education) and occupations. Standard errors are adjusted for clustering on municipality-year and reported in parentheses. Regression analysis reported used STATA 12.0: *** ; ** and * denote statistical significance at the 1; 5 and 10 per cent level, respectively.

Data Source: Labour Force Survey 2004-2007

Proceeding to results presented in second column of Table 1, the effect remains strong and in the same direction when we control for year-specific effects, thus estimating the public sector coefficient using the within-years (cross-sectional) variation.

Interestingly, however, it becomes insignificant (not different from zero) when we additionally include area fixed effects (thus estimating on the basis of area-specific deviations from the full-period average) as presented in column 3 of Table 1. In contrast to prior expectations, that public sector employment may concentrate at the local level in (low-wage) 10" "

areas with less vibrant private sectors, the result of column 3 suggests instead that selection, to the extent that it exists, runs in the other direction (with public sector jobs concentrating instead in high-wage areas – presumably in large cities where wages also tend to be higher).

Column 4 in Table 1 shows that the result is unchanged when we allow the public sector effect to be non-linear: the estimated coefficients indicate a concave relationship, which is however not statistically significant at any acceptable level. In contrast, column 6 indicates that the relationship between public sector presence and private sector wages becomes statistically significant and strongly concave when public sector presence is measured in terms of the total public sector wage bill (as a share to total wage incomes in the local economy). Note also that when we restrict the relationship to be linear, in column 5, the estimated effect is not statistically significant.

Comparing the result in column 6 with that of column 4, suggests clearly that local private sector wages are not in effect influenced by the size of the public sector employment but rather by the relative weight that this has, in pecuniary terms, to the local economy. This, in turn, seems to be more consistent with the wage-push (through bargaining) and incomespillover (through consumption/demand) explanations than with explanations that may see the public sector as restricting labour supply (either through competition for a quasi-fixed supply of labour or via wait unemployment).

To gain more insights about this relationship, we repeat our analysis at a wider spatial scale, namely at the district level. These results are presented in Table 2.

Table 2: Effect of Public Sector Size on Private Sector Wages at the District Level!

Public"defined"as:" Variables:" Experience"

Employment" Employment" share" share" " " 0.012***"

0.012***"

WageCbill" share" "

WageCbill" share" "

0.012***"

0.012***"

"

(0.002)"

(0.002)"

(0.002)"

(0.002)"

Experience"Sq."

C0.023***"

C0.023***"

C0.023***"

C0.023***"

"

(0.005)"

(0.005)"

(0.005)"

(0.005)"

Public"Sector"

0.395*"

1.629**"

0.072"

1.941***"

" Public"Sector" squared" "

(0.223)"

(0.743)"

(0.176)"

(0.683)"

"

C1.550*"

"

C1.791***"

"

(0.907)"

"

(0.630)"

Constant"

3.767***"

3.544***"

3.941***"

3.481***"

"

(0.138)"

(0.179)"

(0.128)"

(0.198)"

Observations"

7,615"

7,615"

7,615"

7,615"

11" "

Year"and" Area" 0.372"

Fixed"effects" RCsquared"

Year"and" Area" 0.372"

Year"and" Area"

Year"and" Area"

0.371"

0.372"

Notes to Table 2: All regressions include controls for personal characteristics (gender, marital status, education) and occupations. Standard errors are adjusted for clustering on municipality-year and reported in parentheses. Regression analysis reported used STATA 12.0: *** ; ** and * denote statistical significance at the 1; 5 and 10 per cent level, respectively.

Data Source: Labour Force Survey 2004-2007

In all cases in Table 2 (columns 1 - 4), the public sector effect appears to be stronger and more positive. In the linear models, the employment share measure (column 1) returns now a positive effect which is significant at the 10 per cent level, while the estimated effect for the wage-bill share measure (column 3) is now also positive, although it remains statistically not significant.

More interestingly, in the non-linear models in columns 2 and 4 we now see a statistically significant (jointly, at the 5 per cent level) effect of public sector size on private sector wages.

This effect is positive and concave also for the case of the employment share measure of public sector presence (column 2).

In addition, the (joint) significance of the linear and quadratic terms in the wage-bill specification presented in column 4 of Table 2 is also strengthened in comparison to the similar regression at the municipal level showed in column 6 in Table 1. Depicting these results in Figure 1 as red (based on column 6 in Table 1) and purple (based on column 4 in Table 2) lines can be seen that the effect becomes significantly larger in size when moving from municipality to district level estimates.

Figure 1: Non-linear Effect of Public Sector Size on Private Sector Wages

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0,6" 0,5" 0,4" 0,3" 0,2" 0,1"

C0,1"

0,01" 0,05" 0,09" 0,13" 0,17" 0,21" 0,25" 0,29" 0,33" 0,37" 0,41" 0,45" 0,49" 0,53" 0,57" 0,61" 0,65" 0,69" 0,73" 0,77" 0,81" 0,85" 0,89" 0,93" 0,97"

0"

PS_W_M"

PS_E_D"

PS_W_D"

!

Notes to Figure 1: PS_W_M denotes public sector measured as wage bill share at the municipality level. PS_W_D denotes public sector measured as wage bill share at the district level. PS_E_D denotes public sector measured as employment share at the district level. All regressions include controls for personal characteristics (gender, marital status, education) and occupations, as well as year and area (municipality/district) fixed effects.

Data Source: Labour Force Survey 2004-2007

Overall, the results obtained at the district level are again consistent with the wage-push and income-spill-over hypotheses. Nonetheless, the fact that the estimates appear stronger in models estimated at wider spatial scales, further suggests that the relationship that links public sector presence to private sector wage outcomes is not particularly localised. In particular, an individual’s wage, net of their personal and job characteristics (such as experience, education, gender, occupation, etc.), is positively (albeit in a concave fashion) associated with the public sector size, in pecuniary terms. This correlation is not only in public sector immediate locality but more so in the area surrounding her locality more widely.

As was found before, for the case of municipal-level public sector presence, the positive wage effect of the public sector declines for very high concentrations of public sector employment. However, as is shown in Figure 1, the effect does not turn negative even for ratios of public sector presence that go well beyond what is observed empirically in our sample.

5. Conclusions and Policy Implications

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This paper has examined the effects of public sector size on local private sector wages in a transition economy by using the case of Serbia. This country was one of the last transition economies that transformed its labour market from public sector domination into a market system.

An investigation of public sector size effects on local labour markets on the case of Serbia as a transitioning country, allows us to observe how processes of transition, market liberalisation, public sector downsizing and/or modernisation (including a relative up/downskilling), and economic restructuring (in the private sector) shape, and are shaped by, the ways in which the presence of the public sector distorts, recalibrates, or even improves labour market efficiency and outcomes at the local level.

Using individual-level data in a Mincerian wage regression expanded by area-specific (yearspecific) fixed effects we estimated public sector size effect on individual net wages net of worker and job characteristics. Estimates were obtained using two alternative measures of public sector size (employment share and share to wage-bill) and at two geographical scales (municipalities and districts), and also examining in cases the presence of non-linearities (by extending the model to include quadratic terms of the public sector variable). We found positive effect of public sector size on individual private sector wages at both municipality and district level. However, the effect is stronger when public sector size is measured as wage-bill share rather than as employment share. Moreover, the estimates appear stronger in models estimated at wider spatial scales.

Positive effect of public sector size on local private sector wages points toward potential wage-push and income-spill-over effects. The non-linearity of the relationship between public sector size and private sector wages at the local level and the fact that it is stronger at wider spatial scales, suggests that wage-push may be a more relevant mechanism underpinning the observed empirical relationship. Particularly, if the income effect was the main mechanism, then there would be no specific reason why the size of the effect would decline for high concentrations of public sector presence.

Nevertheless, the main conclusion that comes from our analysis is that the presence of the public sector does not seem to be associated with any particularly adverse effect on the supply of labour for the private part of the economy. The effect is not so much through the size (employment share) of the public sector but rather through its economic weight (wagebill share) and certainly it does not seem to be hindering labour demand (as the effect on 14" "

equilibrium wages is in any case positive). In this sense, the impact of public sector employment on private sector wages should not be of any particular negative concern.

Instead, the decline in public sector employment, and importantly the decline in public sector wages, through more recent austerity and public sector downsizing policies, may have significant adverse effects for the economy (and, importantly, not in a localised fashion), as it will exert downward pressures on private sector wages and thus on total labour incomes in the economy. To the extent that our positive coefficients have to do with consumption spillovers, this will have a negative effect also on private-sector activity, perhaps similar to what has been observed in economies such as that of Greece, where drastic public sector wage cuts transmitted a negative shock to the private sector too, resulting in a substantial rise in

unemployment

over

a

very

short

period

of

time.

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6. References Albrecht, J., Navarro, L. and Vroman, S., 2011. Public Sector Employment in an Equilibrium Search and Matching Model, 2011 Meeting Papers 390, Society for Economic Dynamics.

Algan, Y., Cahuc, P. and Zylberberg, A., 2002. Public Employment and Labour Market Performance, Economic Policy, 34, 7–65.

Alesina, A., Danninger, S. and Rostagno, M.V., 1999. Redistribution through public employment: the case of Italy, NBER Working Paper 7387.

Arandarenko, M. and Nojković, A., 2007. The labour market in Serbia: Overview, Labour Market Research Report, Employed Empowered.

Bradley, J., Postel-Vinay, F. and Turon, H., 2011. Public Sector Wage Policy and Labour Market Equilibrium: a Structural Model, Working Paper.

Burdett, K., 2012. Towards a theory of the labor market with a public sector, Labour Economics 19, 68-75.

Gomes, P., 2010. Fiscal Policy and the Labor Market: The Effects of Public Sector Employment and Wages, IZA Discussion Papers 5321, Institute for the Study of Labor (IZA).

Holmlund, B. and Lindén, J., 1993. Job Matching, Temporary Public Employment, and Equilibrium Unemployment, Journal of Public Economics, 51, 329-343.

Hörner, J., Ngai, R. and Olivetti, C., 2007. Public Enterprises and Labor Market Performance, International Economic Review, 48(2), 363-384.

Jacobsen, J., 1992. Spillover Effects from Government Employment, Economics Letters 39, 101-104.

Lacriox, R. and Dussault, F., 1984. The Spillover Effect of Public-Sector Wage Contracts in Canada, Review of Economics and Statistics 66(3), 509-512.

Nikolic, J., 2014. Effect of Large-scale Privatisation on Public Sector Pay Gap in a Transition Economy, Economics of Transition, 22(4), 759-781.

Moretti, E., 2004. Estimating the Social Return to Higher Education: Evidence from Longitudinal and Repeated Cross-Sectional Data, Journal of Econometrics 121:1–2, 175–212.

Faggio, G. and Overman, H., 2014. The Effect of Public Sector Employment on Local Labour Markets, Journal of Urban Economics, 79(C), 91-107.

Telegdy, Á., 2014. Public Wage Spillovers. Identification from a Large and Unexpected Public Wage Increase, Working paper.

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Quadrini, V. and Trigari, A., 2008. Public Employment and the Business Cycle, Scandinavian Journal of Economics, 03, 109 (4), 723–742.

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