As most of you know, the public sector is shedding jobs at a furious pace, particularly at the local level. This certainly makes the employment picture looks worse than it would if Martian revenues allowed state and local governments to continue hiring personnel.
There are many interpretations of what’s happening. One is that the public sector expansion over the last decade has proven unsustainable, and states and cities will have to reduce employment levels to 2000 levels, when, as you’ll recall, police officers traveled by donkey cart and communicated by tin can.
I kid, I kid. Our population is larger than it was in 2000, and I imagine that there are certain services that are more expensive to deliver now than had been the case in light of Baumol’s cost disease. But does that account for all of the increase? That doesn’t seem plausible, though I’m certainly open to other interpretations.
But do take a look at this chart prepared by Mercatus Center Research Fellow Matt Mitchell. I can’t actually reproduce the chart (yet!), but here’s what it tells you:
Shown below is the spending level for each year from 1950 to 2009, represented as an index using base year 1950. Put differently, this chart compares spending by state and local governments to spending in the private sector by graphing all spending in terms of its 1950 level. The differences are startling: since 1950, private spending has increased 5-fold while state and local government spending has increased nearly 10-fold.
Notice that the while the curve for private spending from 2000 to 2009 was pretty steep, the curve for state and local spending was steeper.
This reminds me of our recent discussion of Jeffrey Keefe’s research, which was cited by defenders of state and local government wage bills as evidence that public sector workers are not overcompensated. But as Keefe explicitly states, there are some wrinkles:
On average, state and local public-sector workers are more highly educated than the private-sector workforce; 54% of full-time state and local public sector workers hold at least a four year college degree compared to 35% of full-time private-sector workers. State and local governments pay college-educated labor on average 25% less than private employers. The earnings differential is greatest for professional employees, lawyers, and doctors. On the other hand, the public sector appears to set a floor on compensation. The compensation of workers with a high school education is higher for state or local government employees, when compared to similarly educated workers in the private sector. [Emphasis added.]
Moreover, Keefe notes that local government employees aren’t undercompensated even under his assumptions. And his basis for arguing that college-educated state government employees are undercompensated, he relies on educational credentials as a proxy for productivity:
Ideally, we would compare workers performing similar work in the public sector with the private sector, but this is not always possible. There are too many critical occupations in the public sector, for example, police, fire, and corrections, without appropriate private-sector analogs. Even private and public teaching is significantly different. Public schools accept all students, while private schools are sometimes highly selective and may exclude or remove any poor performers, special needs, or disruptive students. Consequently, comparing workers of similar “human capital” or personal productive characteristics and labor market skills is considered the best alternative, and well accepted by labor economists. Analyses based on personal characteristics comparisons capture most of the important and salient attributes observed in the comparable work studies.
But given that, as Keefe states, full-time public employees “work fewer hours, particularly employees with bachelor’s, master’s, and professional degrees,” it seems reasonable to assume that workers with bachelor’s, master’s, and professional degrees who prefer a more leisurely pace of life are sorting into public sector employment. Keefe corrects for hours. But this is tricky, given that pay-for-performance is rare in the public sector and the pace of work is determined by the broader environment.
Layering conjecture on conjecture on conjecture, it looks as though we had a fast-expanding public sector workforce that (a) insulated less-skilled workers by offering them above-market wages and (b) provided attractive opportunities for skilled workers who don’t like working long hours or pay-for-performance schemes.
Given that pay-for-performance has been a huge driver of productivity growth, as Edward Lazear and many others in the field of personnel economics have argued. What does performance pay do? There’s been more research since Lazear, but here are some of his core findings:
1. A switch to piece-rate pay has a significant effect on average levels of output per worker. This is in the range of a 44-percent gain.
2. The gain can be split into two components. About half of the increasei n productivity results from the average worker producing morebecause of incentive effects. Some of the increase results from an ability to hire the most productive workers and possibly from a reduction in quits among the highest output workers. None reflects the “Hawthorne ffect.”
3. The firm shares the gains in productivity with its workforce. A given worker receives about a 10-percent increase in pay as a resultof the switch to piece rates.
4. Moving to piece-rate pay increases the variancein output. More ambitious workershave less incentive to differentiate themselveswhen hourly wages are paid thanwhen piece-rate pay is used.
One implication is that lockstep compensation schemes, like the kind you find in state and local employment, might prompt “quits among the highest output workers.”
All this is to say that shedding public sector jobs might be a crucial step to creating a more productive economy over the long-term. If large numbers of public sector workers are effectively overcompensated — the clear implication of Keefe’s analysis about the wage floor — this creates an expensive drug for private sector workers.
At the same time, this is clearly causing dislocation and short-term pain, and it will take time for these public employees to find work commensurate with their skills. Many will have a hard time finding work that is as remunerative again. That’s why I’d be comfortable with a program that created temporary public jobs at very low wages, modeled on William Julius Wilson’s proposal for employing the long-term unemployed in his book When Work Disappears. Wage bills would be dramatically reduced, yet these workers would still be engaged in productive labor until they’re able to find appropriate private sector work.
This will strike many readers as draconian. But if our concern is the overall employment level, it’s not obvious that keeping workers in unreformed public sector institutions employed is the shrewdest strategy. Think of the case for moderate inflation. It rests on the idea that wages are sticky, and that moderate inflation will reduce real wages without the emotional suffering. We can’t just impose moderate inflation of public sector workers, but it’s clear that we need an approach that will do something very much like that. None of the options are pretty — real people, real families will bear the brunt. But of course real people and real families bear the brunt of the state and local tax burden, including many less-skilled workers who don’t enjoy the public sector wage premium.