Municipal Labour Demand : The Efffects of Intergovernmental Grants in Finland and Sweden

Abstract: This paper investigates the effects of intergovernmental grants on municipal labour demand in Finland and Sweden during the period 1985-2002. Both these countries have large public sectors in which local authorities play a significant role. In addition, both countries went through major grant reforms in 1993, reforms that meant that most targeted grants were replaced by general, non-earmarked grants. This allows for studying the effects of the different types of grants separately. The results suggest that targeted grants affect Finnish municipal employment more than general ones do, at least when looking at levels. When looking at elasticities, however, the opposite is indicated. In Sweden intergovernmental grants appear to have no effect at all on municipal employment before the reform, but after the estimated elasticity is 0.10. This is somewhat lower than in Finland, where the estimated elasticities are 0.13 and 0.14 before and after the reform, respectively. The results also lend additional support to the so called “flypaper effect”, an empirical phenomenon that has been observed in numerous previous studies.