Does public‐sector employment fully crowd out private‐sector employment?

Employment matters for development because it can raise household income, lower inequality, promote economic growth, and contribute to political stability. Many countries have high rates of public employment, but what effect does this have on overall employment and unemployment rates? This paper investigates if and to what extent public‐sector employment crowds out (reduces) private‐sector employment. In particular, we estimate regressions of unemployment or private‐sector employment on two measures of public‐sector employment. The study uses an especially assembled dataset, which is novel for its coverage of a large sample of developing countries as part of a panel of rich and poor countries. Our results point to full or just about full crowding‐out for the entire sample. Unlike previous cross‐country studies, which were restricted to advanced economies, we are able to show that these results also apply to developing countries, although crowding‐out may not be quite as high as in advanced economies. The results mean that high rates of public employment have an offsetting large negative impact on private employment rates and do not reduce overall unemployment rates. With the qualifier that government activities may help the economy in other ways, our results imply that, rather than creating public‐sector jobs, scarce fiscal resources could be better spent on other developmental needs.