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Cost disease in defense and public administration: Baumol and politics

Lars-Erik Borge (), Kjetil Hatlebakk Hove (), Tobias Lillekvelland () and Per Tovmo ()
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Kjetil Hatlebakk Hove: Norwegian Defence Research Establishment (FFI)
Tobias Lillekvelland: Norwegian Defence Research Establishment (FFI)
Per Tovmo: Norwegian University of Science and Technology

Public Choice, 2018, vol. 175, issue 1, 1-18

Abstract: Abstract William Baumol’s model predicts a steady increase in relative public sector prices (or costs) because of the combination of slow productivity growth and wage growth similar to sectors wherein productivity is growing more quickly. In this paper, we extend the Baumol model with political variables and analyze price growth in defense and public administration using Norwegian data. We find strong support for the mechanism of the Baumol model since manufacturing productivity is the most important determinant of relative public-sector prices. Greater political fragmentation has also contributed to the price growth, but its quantitative effect is smaller than that of manufacturing productivity. An analysis of a labor-intensive private service (restaurants and cafes) supports the broader relevance of the Baumol mechanism and the validity of the estimated effect of political fragmentation on the two sectors considered herein.

Keywords: Baumol mechanism; Public sector prices; Political fragmentation; Error correction model (search for similar items in EconPapers)
JEL-codes: H11 H40 H56 (search for similar items in EconPapers)
Date: 2018
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