Public sector employment and aggregate fluctuations

An important stylized fact about public sector employment is that it predominantly hires skilled and more experienced workers. In this paper, we consider a search and matching model with public sector and on-the-job human capital accumulation that incorporates this stylized fact to study how the public sector employment affects the labor market volatility. In the model, public sector employment affects aggregate fluctuations by changing the composition of workers employed in the private sector. Because workers accumulate human capital and become more productive when employed, the flow of benefits from forming a match are spread over time. In this environment, if the flow into the public sector increases with human capital, then the government hiring policy decreases the firm’s benefit of hiring and the matching surplus, increasing the responsiveness of labor market tightness to shocks. We calibrate the model for the Brazilian economy and show that this mechanism amplifies the effects of public employment on vacancy creation and private sector employment volatility.