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Bridging the Wage Gap: The Fiscal and Economic Gains of Reducing Government Employment Inefficiencies

Author

Listed:
  • Oscar Valencia
  • Alfredo Villca
  • Carolina Ulloa-Suárez
  • Gustavo Sánchez

Abstract

This paper examines the macroeconomic and fiscal benefits of reducing inefficiencies in public sector wages, with a focus on the public–private wage premium. Using cross-country empirical evidence, along with a Dynamic Stochastic General Equilibrium (DSGE) model calibrated to Latin America and the Caribbean, we show that narrowing the wage gap yields substantial benefits. A one percentage point reduction in the premium improves the primary balance, lowers debt, and raises output and private employment, without generating inflationary pressures. Extensions show that the adjustment mechanism is key: gains are larger and faster when wage rigidities are limited and reforms are sustained, while employment cuts provide stronger fiscal relief at higher economic costs. These results underscore the importance of efficient and well-designed compensation policies in enhancing fiscal sustainability and promoting long-term macroeconomic stability.

Suggested Citation

  • Oscar Valencia & Alfredo Villca & Carolina Ulloa-Suárez & Gustavo Sánchez, 2025. "Bridging the Wage Gap: The Fiscal and Economic Gains of Reducing Government Employment Inefficiencies," Working Papers of BETA 2025-49, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    • Handle: RePEc:ulp:sbbeta:2025-49
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    File URL: http://beta.u-strasbg.fr/WP/2025/2025-49.pdf
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    Keywords

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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • J45 - Labor and Demographic Economics - - Particular Labor Markets - - - Public Sector Labor Markets

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