Our model endogenizes the share of public sector employment in a neoclassical growth model. Under the assumptions that public sector production is labor intensive and the elasticity of substitution between capital and labor is less than one, the public share of employment is shown to decline with a rise in capital per effective worker. Our theory predicts that periods of high productivity growth are associated with a rising trend of the public share of employment. This prediction conforms well with U.S. experience from 1950–1995.
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