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Rolling Back the Public Sector - Differential Effects on Unemployment, Investment and Growth

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  • van der Ploeg, Frederick

Abstract

The macroeconomic effects of different ways of rolling back the welfare state are analysed. Cutting public spending on market goods induces a lower interest rate, a higher wage, a lower capital stock and a fall in employment. Cutting public employment or the labour income tax rate leads, in contrast, to a lower wage, a higher interest rate and a higher capital stock. Employment rises on impact. If the extra revenues of rolling back the welfare state are handed back via a lower tax rate rather than a lump-sum subsidy, both cutting public employment and cutting public spending on market goods induce an investment boom. Making the tax system less progressive by cutting tax credits and the labour income tax rate induces an investment boom as well. The effects of endogenous growth, adjustment costs for investment and non-Walrasian labour markets on these results are considered as well.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4896.

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Date of creation: Feb 2005
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Handle: RePEc:cpr:ceprdp:4896

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Keywords: fiscal retrenchment; growth; investment; labour market; public employment;

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  1. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June.
  2. Alesina, Alberto F & Ardagna, Silvia & Perotti, Roberto & Schiantarelli, Fabio, 1999. "Fiscal Policy, Profits and Investment," CEPR Discussion Papers 2250, C.E.P.R. Discussion Papers.
  3. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-24, January.
  4. Frederick VAN DER PLOEG, 2004. "DO SOCIAL POLICIES HARM EMPLOYMENT? Second-best effects of taxes and benefits on labor markets," Economics Working Papers ECO2004/11, European University Institute.
  5. Evi Pappa, 2005. "New Keynesian or RBC Transmission? The Effects of Fiscal Policy in Labor Markets," Working Papers 293, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  6. Atkinson, Anthony B & Micklewright, John, 1991. "Unemployment Compensation and Labor Market Transitions: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 29(4), pages 1679-1727, December.
  7. Lockwood, Ben & Manning, Alan, 1993. "Wage setting and the tax system theory and evidence for the United Kingdom," Journal of Public Economics, Elsevier, vol. 52(1), pages 1-29, August.
  8. Calmfors, Lars & Horn, Henrik, 1986. "Employment Policies and Centralized Wage-Setting," Economica, London School of Economics and Political Science, vol. 53(211), pages 281-302, August.
  9. Pappa, Evi, 2005. "New-Keynesian or RBC Transmission? The Effects of Fiscal Shocks in Labour Markets," CEPR Discussion Papers 5313, C.E.P.R. Discussion Papers.
  10. Finn, Mary G, 1998. "Cyclical Effects of Government's Employment and Goods Purchases," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 635-57, August.
  11. Holmlund, Bertil, 1997. "Macroeconomic Implications of Cash Limits in the Public Sector," Economica, London School of Economics and Political Science, vol. 64(253), pages 49-62, February.
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Cited by:
  1. Petrucci, Alberto & Phelps, Edmund S., 2009. "Two-sector perspectives on the effects of payroll tax cuts and their financing," Journal of Public Economics, Elsevier, vol. 93(1-2), pages 176-190, February.
  2. Giovanni Ganelli, 2005. "The International Effects of Government Spending Composition," IMF Working Papers 05/4, International Monetary Fund.
  3. W. Robert Reed, 2009. "The Determinants Of U.S. State Economic Growth: A Less Extreme Bounds Analysis," Economic Inquiry, Western Economic Association International, vol. 47(4), pages 685-700, October.
  4. Frederick van der Ploeg, 2003. "Do Social Policies Harm Employment and Growth?," CESifo Working Paper Series 886, CESifo Group Munich.

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