Magazine | April 18, 2011, Issue

Where the Jobs Aren’t

Public-sector cartels are choking off economic growth

One of the bright spots in our otherwise dismal recovery has been the strength of U.S. exports, which have risen to 12.8 percent of GDP from 10 percent a decade ago. States dominated by factories and farms have fared relatively well as booming emerging markets have gobbled up American industrial equipment and agricultural goods. There is no guarantee that exports will continue to climb as the global economy slows down. Yet it remains striking that the strongest part of the American economy is the part that faces the most vigorous international competition.

In March, the economists Michael Spence and Sandile Hlatshwayo published a report called “The Evolving Structure of the American Economy and the Employment Challenge,” a detailed account of how the American labor market changed between 1990 and 2008. Many, including columnist Steven Pearlstein of the Washington Post, believe that the report bolsters the case for activist government. But Spence and Hlatshwayo have also offered ammunition to those who believe that public-sector cartels threaten to choke off economic growth.

The central premise of the report is that there has been a dramatic divergence between the parts of the economy that are internationally tradable and those that are not. U.S. firms that sell goods and services that can be shipped or delivered electronically face lean and hungry competitors and potential competitors around the world. The good news is that U.S. firms have risen to the challenge, sharply increasing output while keeping costs contained, largely through greater specialization.

But the need to contain costs has meant that large numbers of low- and mid-skill jobs have been shed or sent offshore. While knowledge-intensive industries have seen big gains in employment, traditional blue-collar manufacturing work is vanishing at an accelerating pace. On balance, employment in the tradable sector was flat from 1990 to 2008.

The nontradable sector, in contrast, has seen rapid employment growth over the same period. There were 27.3 million more jobs in 2008 than in 1990, and 26.7 million of those were in the nontradable sector. This sector, which includes government, health care, retail, accommodation and food, and construction, operates in a very different environment from that of the tradable sector. The largest employer in the nontradable sector is government, which accounted for 22.5 million of the 149.2 million U.S. jobs in 2008, and 4.1 million of the new jobs that were added between 1990 and 2008. Health care, a sector heavily subsidized and regulated by the government, accounted for an additional 16.3 million jobs in 2008, 6.3 million of which had been added since 1990.

As Spence and Hlatshwayo acknowledge, it is extremely difficult to measure productivity in these sectors, because there is no way to tell what consumers would pay for such services in an open market. The best we can do is measure the inputs: Public schools, for example, are evaluated on the basis of how much local taxpayers spend on them, not how much parents would pay to enroll their children in them.

Spence and Hlatshwayo are careful not to speculate about the drivers of the expansion in government and health-care employment. But one could argue that the last decade saw a kind of undercover fiscal stimulus, particularly at the state and local level. Productivity growth in high-end services and manufacturing translated into income gains for high-skilled workers and asset-rich households, which swelled state and local tax revenues. This revenue was then channeled into politically popular efforts to reduce class sizes and expand the reach of Medicaid, among other measures. As the number of taxpayer-financed jobs increased, so too did the constituency for the growth of government.

One reason we see so much protest when state and local governments have tried to roll back spending may be that many public employees who insist that they’ve endured steep pay cuts relative to what they’d make in the private sector recognize that this is very far from the case. For them, thanks to the hidden stimulus, the personal stakes are high.

#page#Politics aside, Spence and Hlatshwayo suggest that the growth in public-sector employment will not continue unabated as public-debt levels and taxes rise. Other nontradable industries, such as real estate and construction, are also unlikely to grow rapidly, in employment or in total output. And while employment levels have remained fairly high in the accommodation and food sector, total output is relatively low, which accounts for the sector’s low wages and incomes.

The authors leave us with a bleak picture of the future employment landscape. While the tradable sector has in some sense flourished, it has not generated enough middle-class jobs to absorb the country’s large and growing number of less-skilled and mid-skilled workers. It doesn’t help that many of these workers are Latino and black, a fact that could deepen existing cultural and political divides. Growth in the nontradable sector, particularly in government and health care, has proven unsustainable, and no amount of fiscal stimulus will change that fact.

At the end of their report, Spence and Hlatshwayo offer a familiar litany of policy proposals to address the death of good middle-class jobs, ranging from infrastructure investments to more federal research-and-development spending to tax reform.

These ideas fail to get at the heart of the problem, which is the sluggishness of productivity growth in the nontradable sector, and in particular in education and health care. Had productivity in the nontradable sector increased as quickly as it did in the tradable sector, the United States would be far richer than it is today.

To be sure, many existing firms and employment categories would have shed jobs. But the wealth created by this productivity boom would have increased the demand for labor-intensive services. That is roughly what happened in the 1990s, when the retail sector experienced an unprecedented productivity boom that helped lower prices of consumer goods while also raising wages. The extreme inefficiency of the public sector is a product of the same rigid work rules and compensation schemes that hobbled the private sector in the era of stagflation. While politicians from the president on down have given lip service to the public-sector-productivity problem, all but a handful have failed to understand its source.

In a highly illustrative July 2009 interview with Bloomberg Businessweek, President Obama recounted a conversation with leading corporate executives. “We talked about the fact that, in the 1980s, when everybody was afraid Japan was going to eat our lunch, a lot of companies did a 180 in terms of quality improvement, efficiency, increasing productivity.” As the president explained, “there was a change in corporate culture that significantly boosted corporate productivity for a long time and helped create the boom of the ’90s.”

What the president ignores is that this “change in corporate culture” was more like a revolution. Firms didn’t embrace quality improvement, efficiency, and increasing productivity merely because fear of the Japanese lit a fire under their behinds. Shrewd executives understood that “corporate raiders” would seize their assets if they didn’t. Thousands of workers were laid off as firms embraced pay-for-performance compensation for managers and front-line workers. The best managers experienced huge gains in earnings as a result, a phenomenon the president has decried as a driver of rising inequality. But the rise of pay-for-performance didn’t reflect a perverse disregard for the working stiffs; it reflected a desire to retain footloose talent, and to survive in the face of fierce competition.

Later in the interview, the president explained that he wanted to see the same productivity revolution transform health care and education. One can make a strong case that part of the reason the “change in corporate culture” did not spread to these nontradable sectors is that they are sectors in which the productivity-enhancing dynamic of competition, liquidation, and innovation was dampened by the heavy role of the state and high levels of union membership. Yet Obama has described Wisconsin governor Scott Walker’s efforts to pare back collective-bargaining rights for state workers as an “assault on unions.”

That the president would defend the status quo in the public sector makes perfect sense, given the political incentives at work. But his desire to insulate public workers from competition will doom all efforts to increase productivity in the most critical parts of the nontradable sector. And that, very bluntly, will make us all poorer than we might otherwise be.

– Mr. Salam is a policy adviser at Economics 21.

Reihan Salam is president of the Manhattan Institute and a contributing editor of National Review.

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