DP16085 Local Public Goods and the Spatial Distribution of Economic Activity

Author(s): Arthur Guillouzouic, Emeric Henry, Joan Monras
Publication Date: April 2021
Keyword(s): Local Public Goods, market power, Public Service, spatial economics
JEL(s): H41, J42, J45, R12
Programme Areas: Labour Economics, Public Economics, Organizational Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16085

Using French data, we provide: a) causal evidence that a drop in local public goods provision decreases private sector activity, and b) evidence consistent with monopsony power of the public sector in local labor markets. We introduce a public sector with these two key characteristics in an otherwise standard spatial equilibrium model, and show that it delivers the main stylized facts established in our data, in particular, that the share of the public sector relative to the private is independent of the productivity of the city. We emphasize the tradeoffs between allowing governments to freely choose local public employment and wages (as in most of the US public sector), versus imposing rules that constrain public sector pay with some indexation to the local cost of living (as in many European countries). We show that wage indexation limits monopsony power -- leading to a larger public sector -- and is optimal if the indexation is sufficiently strong.