The interaction between private sector and public sector labor markets: Evidence from Romania

We quantitatively assess the spillover effects originating from sectoral labor market shocks in an emerging economy (Romania). First, we estimate a time series model to recover data-driven evidence. Then, to blend data with theory, we develop a New Keynesian model which features public and private sector employees, who provide potentially substitutable labor services. In this environment, we allow for an active role of the government, which decides on the optimal amount of public employment, public wages and borrowing. The estimated structural model captures most empirical evidence: public job creation crowds out private sector employment and is contractionary, while increases in public wages lead to muted spillover effects; on the other hand, increases in both private employment and wages have sizable crowding in effects on public sector employees and are strongly expansionary. These results support active labor market policies targeting primarily the private sector developments.