In Chapter Three, we develop a two-player-two-period model that allows us to
investigate the interaction between the central executive’s and the subnational governor’s
decisions on the amount of public employees at both government levels. The theoretical
model yields four hypotheses: first, higher degrees of fiscal decentralization are
associated with higher levels of subnational government employment; second, total
public sector employment is a function of the degree of fiscal decentralization but the
direction is ambiguous, depending on two opposing effects; third, higher levels of GDP
per capita are associated with higher levels of subnational government employment;
finally, the level of subnational government employees is positively correlated with the
ability of the subnational governors to shift the political cost caused from negative
subnational budget gaps to the central executive. An important contribution of this
dissertation is that we incorporate the production function of public goods into both the
central executive’s and subnational governor’s utility function. Within this framework,
we are able to investigate the interaction of decisions on the level of public employees at
both the central and subnational governments. The level of total public sector employees
can be further expressed as a function of the degree of fiscal decentralization, which our
empirical study is based on.