Higher government wages result in slower economic growth

May 7, 2000

Free Market Foundation

Government employment can slow economic growth, according to some economists, as increasing public wages and/or employment raises wage pressure in the private sector. This results in higher wages and benefit packages for the employees, cutting profits and private investment by the companies.

From an analysis of several wealthy nations over the past 20 years, researchers concluded that:

An increase in labor costs equal to 1 percent of the Gross Domestic Product (GDP) leads to a reduction in the investment/GDP ratio of 0.17 percentage points in the first year and 0.7 percentage points over five years.

A cut in the public wages that results in a reduction of labour costs by 1 percent of GDP leads to an immediate increase in the investment/GDP ratio by 0.51 percentage points in the first year, 1.83 percentage points by the second year and 2.77 percentage points after five years.

Thus the authors conclude that increased economic growth would result if government wages were lowered.

Source: NCPA Policy Digest / Alberto Alesina, Silvia Ardagna, Roberto Perotti and Fabio Schiantarelli, “Fiscal Policy, Profits, and Investment,” Working Paper No. 7207, July 1999, National Bureau of Economic Research.

For NBER Abstract: www.nber.org/digest/jul99/w7207.html