Strategic interaction among Japanese municipalities regarding public servant salary levels

It remains unclear whether local jurisdictions consider their neighbors’ salary levels when making changes to their public sector salaries. Following the Great East Japan Earthquake and its aftermath, the Japanese central government introduced several policies aimed at reducing public sector salaries at the local government level, and local governments responded by reducing their employees’ salaries. This study empirically tests the existence of strategic interaction in relation to public sector salary setting among municipal governments in response to central government policies. Using a sample of Japanese municipalities from 2010 to 2016, we developed a spatial model that incorporates both spatial autoregressive disturbances and spatial dependencies. A quasi-experimental strategy was used to solve the endogeneity problem of the spatial lag-dependent variable. We found that changes in salary levels in Japanese municipalities are dependent on the salaries in neighboring municipalities. Several estimation methods were used and produced consistent results. Our study also suggested that yardstick competition could drive strategic interaction in relation to decision making regarding salaries. Moreover, when the central government’s top-down policy is effective, the strategic interactions in public salary settings among neighboring municipalities appear to be strong.