Texto para Discussão, Instituto de Pesquisa Econômica Aplicada (IPEA) 1415
The present work aims to explore the existing theories about the size of the public sector and test empirically in Brazilian municipalities. The theoretical model assumes that the economy has only two sectors: the public and the private. The latter receives productivity shocks while the former operates in a non-stochastic environment but in a less efficient production process. Both sectors produce the same goods. In addition, the representative agent maximizes his utility function which depends on the consumption of both public and private goods. The public sector exists despite of its inefficiency, because the representative agent needs to smooth abrupt variations in his utility function. Panel data with the use of instrumental variables was chosen to the empirical application. The results are: the size of the local public sector in Brazil is positively correlated with the expected value of intergovernmental grants; negatively correlated with the expected value of private output and the variance of private output; statistically uncorrelated with the covariance between private output and intergovernmental grants. Besides the quantitative analysis to municipalities financial data, the major contribution of this work was the adaptation of a model to explain the size of local public sector, embodying federative issues.