Public Versus Private Production Decisions and Redistribution

Abstract

We analyse the decision rules governing public employment policy and capital allocation between private and public sector in a simple two-type and two-sector optimal non-linear income tax model with endogenous wages. Results from a static framework indicate that to produce a given amount of consumption the government should employ more unskilled workers and less skilled workers than is necessary to minimize cost at the prevailing gross wage rate. The potential role of minimum wage as another policy variable is discussed as well. Extending the model into an OLG framework with public and private capital, we show that the discount rate that ought to be used in evaluating public sector projects is not the same as the return to capital in the private sector. In particular, public capital accumulation is favoured if capital in the private sector is complementary with high-skilled labour. Therefore, production efficiency holds neither in public employment decision nor capital allocation.