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

Oscar Valencia, Alfredo Villca, Carolina Ulloa-Suárez and Gustavo Sánchez

Working Papers of BETA from Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg

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.

Keywords: Fiscal policy; Wage premium; fiscal sustainability; DSGE models; Local Projections; Welfare. (search for similar items in EconPapers)
JEL-codes: E62 H50 J31 J45 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:ulp:sbbeta:2025-49

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