Optimal Public Sector Premium, Talent Misallocation, and Aggregate Productivity: Evidence From Egypt

ABSTRACT

We develop a tractable general equilibrium model to quantify the long‐run aggregate productivity gains from adjusting the public‐sector premium and the size of the public sector to their productivity‐maximizing levels. The model incorporates an endogenous choice between market and non‐market activities for women. We calibrate the model to the Arab Republic of Egypt, a country with a disproportionately large share of workers, especially women, in public employment. Conditional on an elasticity of private output with respect to public goods of 0.1, we find that lowering the average public‐sector premium from 22% to its productivity‐maximizing level of 13%, and thereby reducing the public‐sector employment share, generates long‐run gains of 12% in output per worker and 8% in TFP. Notably, a reduced female public‐sector premium fosters greater female labor force participation in market activities: female entrepreneurship rises from 16% to 20%, increasing the demand for production labor and driving wages up, while the share of women in home production falls from 52% to 29%.