What recession? Government workers are probably wondering what all the fuss is about. The private sector has lost 2.5 million jobs since the Obama administration's stimulus bill was passed, while the public sector -- federal, state, and local government combined -- has added 416,000 jobs over the same period. Although 85 percent of Americans work for private employers, the administration's own Recovery Act database admits that four out of five jobs "created or saved" were in government. Likewise, average pay has risen in the federal, state, and local government, while private sector wages have fallen. More jobs, better security, and rising wages -- it's boom time in the public sector.
Ordinary Americans, along with a small group of elected officials from both parties, have finally been stirred to action. New Jersey's Republican governor Chris Christie is a leader in taking on public sector unions over performance, pay, and pensions, and California governor Arnold Schwarzenegger has cajoled public employee unions into accepting pension reductions. Even some Democratic appointees -- such as Washington, D.C., public schools chancellor Michelle Rhee, who recently took the unprecedented step of firing 241 underperforming teachers -- seem to have had enough.
Despite this, defenders of public sector workers continue to argue that they are underpaid. Union representative Colleen Kelley, in a recent letter to the Wall Street Journal, cited federal statistics claiming that federal workers are paid 22 percent less than private sector employees doing similar jobs. Likewise, recent studies from liberal think tanks claim state and local employees receive significantly lower pay and benefits than private workers. Until these arguments are addressed, fully and directly, the group of policy makers with the mettle to tackle public sector pay will remain small.
A raw comparison between the wages of federal and private workers suggests there is no contest at all. The typical federal employee received a salary of more than $79,000 in 2008, with benefits raising total annual compensation to more than $119,000. The typical private sector worker, by contrast, received pay of around $50,000 and total compensation of just under $60,000. Moreover, USA Today recently reported that federal employees receive higher average salaries than private sector workers in 180 of 216 comparable occupations. These numbers seem to speak for themselves.
Defenders of federal pay are quick to point out, however, that federal employees are more skilled than the typical worker in the private sector -- in other words, they deserve more money. As OMB director Peter Orszag argued, "A comparison of federal and private sector pay...is misleading because the employees hired by the federal government often have higher levels of education than their counterparts in the private sector."
Orszag is right: we do need to account for skill differences in the federal workforce, which is older, more educated, and more white-collar than workers in the private sector. But the question then becomes whether these differences are enough to account for the huge disparity in pay. Using the Census Bureau's Current Population Survey, which includes earnings and demographic data on tens of thousands of workers spread across the public and private sectors, we can control for differences in education, work experience, race, gender, marital status, immigration status, region of residence, and several other variables. After doing so, we can see whether the pay gap between federal and private sector workers remains.
This "human capital" approach to explaining wage variation, the overwhelming preference of labor economists, assumes that in competitive labor markets individuals with the same productivity will command similar salaries, even if they work different jobs. The human capital method is commonly used by economists in other contexts -- such as determining whether union members receive higher pay than similarly qualified non-union members, or whether women and minorities receive lower pay than comparable white males.
Even after including the full range of control variables in our own analysis, we found that federal workers continue to earn a pay premium of around 12 percent over private workers. In other words, someone in the private sector has to work an average of 13.5 months to earn what an equally skilled federal worker makes in 12 months. This is not a novel result by any means. Academic economists have been studying federal/private pay disparities since the 1970s, and they generally find a premium in the range of 10 to 20 percent.
Though the data are less precise, benefits like retirement contributions and health insurance rates are also more generous for federal employees. We have calculated that the annual overpayment of salary and benefits to federal workers comes to more than $14,000 per worker, totaling nearly $40 billion per year.
This does not mean everyone in the federal government should get an automatic pay cut. In fact, our data suggest the brightest people -- research scientists, for example -- receive no premium and may even suffer a penalty when they work for the government. If the federal government rewarded skills the way the private sector does, wages would adjust in different ways for different workers. Overall, however, total compensation would go down by around 12 percent, taxpayers would save tens of billions of dollars each year, and the federal government would regain some much-needed fiscal credibility.
BUT WHERE DO CLAIMS THAT federal workers are underpaid come from? From the President's Pay Agent -- not an actual person, but an obscure function headed by the Secretary of Labor and the directors of the Office of Management and Budget and the Office of Personnel Management. Relying heavily on the recommendations of the Federal Salary Council, a panel of labor union representatives, the Pay Agent submits an annual report to the president suggesting how much to increase federal pay. The 2009 report claims, remarkably, that federal workers are underpaid by more than 22 percent relative to the private sector.
Before we discuss the reasons for the large discrepancy between the Pay Agent's results and ours, consider how implausible the 22 percent figure actually is. Why would millions of federal employees accept such a low wage if they could earn thousands more in the private sector? A desire to serve the public can go only so far. High-ranking government officials are no doubt attracted to the power and prestige of their jobs, but what about the vast number of unremarkable paper-pushing jobs the government offers? What is so attractive about these positions that justifies taking 78 cents on the dollar?
Barring an almost unbelievable level of civic-mindedness on the part of federal employees, either federal positions offer non-wage compensation that outweighs a 22 percent salary gap -- in which case these workers aren't truly underpaid -- or the 22 percent salary gap figure is wrong to begin with. We think both are true.
The Pay Agent's figure is inaccurate because of the method it uses to compare pay in each sector. Rather than using skills like education and experience to identify productivity, as most economists recommend, the Pay Agent relies on a survey of job descriptions in various localities. For example, suppose the federal government employs an accountant in Chicago. In order to determine how much to pay him, the government would look at the job descriptions of private sector accountants in the Chicago area. It would try to find the subset of accountants who seem to have the same responsibilities as the government hire, then take the average salary in that set.
Though it sounds reasonable enough, the process is highly subjective. Positions that seem "comparable" on paper could be much different in practice, and some federal jobs have no private sector counterparts. How much should an intelligence analyst be paid based on his job description? Most importantly, unlike the human capital approach, the Pay Agent cannot distinguish between high- and low-productivity workers in the same position. It is just assumed that a particular job description leads to a certain level of output.
That is a rather poor assumption, because government appears to systematically promote employees to higher positions than they could hold in the private sector. An individual who would serve as a junior accountant in the private sector, for example, might be a senior accountant for government. One study found that 77 percent of federal employees are at least one level of responsibility above that of comparable workers in the private sector. This means government positions may appear underpaid relative to comparable private sector occupations, but the individuals filling those positions could be overpaid relative to what they would earn outside of government. The Pay Agent's method is inherently oblivious to this problem.
Even the federal Pay Agent's own analysts have expressed strong reservations about the government's system for setting wages. The 2008 report states, "We continue to have major methodological concerns about the underlying model for estimating pay gaps." Each report between 2001 and 2008 included some version of this warning. Curiously, the first report produced by the Obama administration omitted any mention of reform.
THE PAY AGENT'S FIGURES are even less believable when we consider just how popular government jobs are. At the beginning of this year, federal workers were only one-third as likely as private sector workers to quit their jobs, a difference that exists during good economic times as well as bad. Since perhaps the most common reason for quitting a job is to take another that offers some combination of better wages, benefits, and working conditions, the fact that federal workers don't jump ship implies there is usually no better deal out there. Government job postings also receive considerably more applications than private sector openings, again pointing to their attractiveness.
In 1988, economist Alan Krueger -- currently serving the Obama administration as chief economist at the U.S. Treasury Department -- examined the wages of two different groups of people who were laid off from their private sector jobs. One group took new jobs in the private sector, while the other group became federal employees. The latter group, unsurprisingly, made significantly more money after the job change than the former. These results, together with the evidence on quit rates, application quantity, and sheer gut-level plausibility, form a solid block of evidence supporting the findings of superior federal pay, benefits, and working conditions.
Comparisons for state and local government workers are more complicated, because here it is mainly benefits, not wages, that make government work attractive. John Schmitt of the left-leaning Center for Economic and Policy Research (CEPR) recently wrote, "When state and local government employees are compared to private sector workers with similar characteristics, state and local workers actually earn less, on average, than their private sector counterparts." In contrast to the federal case, there are hard numbers to back up this claim-at least when the case is limited to wages.
While the human capital approach shows a 12 percent wage premium for federal government employees, it tends to show a pay penalty at the state and local level of 10 to 12 percent. It is not clear why state and local workers receive lower wages than federal employees -- competition among the states might play a role in keeping salaries in line -- but unions and liberal think tanks have seized on this finding to claim that state and local workers are undercompensated.
This conclusion does not survive scrutiny. For one thing, state and local employees are five times more likely to be covered by union contracts than private sector employees. Since union members predictably receive higher pay than non-union members, policies to allow collective bargaining by government employees are tantamount to decisions to raise pay. While some analysts would have you believe that state and local employees are paid just like private sector workers, the truth is that they are paid more like unionized private sector workers, which is a different kettle of fish.
Moreover, at both the state and local level, generous benefits are likely to more than make up for any salary gap, large or small. While studies by think tanks like the CEPR claim that benefit levels are comparable between state/local and private sector workers, they employ a serious methodological error.
The basic method of comparing benefits for public and private sector workers is simple: use data on what employers pay for each employee's fringe benefits, such as health insurance and pensions. In the private sector this method usually works fine. Employee benefits take the form of an up-front payment -- a matching contribution to a 401(k) account, for example -- not an IOU like a pension plan.
In the public sector, however, this approach can be quite misleading because a good portion of government employees' benefits come in the form of defined benefit pensions and retiree health coverage. These benefits are both highly generous and severely underfunded, which means that what government employers currently pay for these benefits significantly understates the benefits employees will become entitled to and must eventually collect.
Public sector pension plans reported unfunded liabilities of approximately $500 billion as of 2008. When measured by the more rigorous standards required for private pension plans, however, public pensions are underfunded by more than $3 trillion. Added to this is approximately $500 billion in unfunded obligations for generous retiree health benefits, which provide full coverage from the age of retirement through Medicare eligibility at 65, then supplemental coverage thereafter.
Unlike programs like Social Security, where underfunding can mean benefit cuts, accrued public sector pension benefits are in most states guaranteed either by law or by state constitutions. In other words, state government employees are eligible for $3.5 trillion more in benefits than labor compensation data would suggest, because these reflect only what employers do pay, not what they should pay if they are to meet their obligations. When the full value of pension and retiree health entitlements is included, total compensation for state and local employees rises by approximately 25 percent, putting these employees thousands of dollars ahead of their private sector counterparts.
EVEN LEAVING WAGES AND BENEFITS aside, the intangible perks of public employment -- automatic annual raises, flexible hours, generous paid vacation time -- provide significant added value. Then there is the near-certainty of not being fired. The annual rate of layoffs and firings in 2009 was 24 percent in the private sector but only 7 percent in state and federal government. Given that the average duration of unemployment in 2009 was more than 22 weeks -- and is even higher today -- this additional job security for public sector employees has an expected value of more than $8,000 for a typical federal employee. In practice, individuals would gladly pay even more for this insurance, since layoffs and firings tend to happen at the worst possible times -- when the economy is down and millions of other workers are looking for jobs.
The cost of public sector overcompensation goes beyond higher taxes. Economists Yann Algan, Pierre Cahuc, and Andre Zylberberg write in the Economic Policy Journal that, on average, "creation of 100 public jobs may have eliminated about 150 private sector jobs, slightly decreased labor market participation, and increased by about 33 the number of unemployed workers." Their conclusion, drawn from data on 17 Organisation for Economic Co-operation and Development (OECD) countries over the period 1960 to 2000, is that attractive pay and conditions in public employment make private sector positions less attractive to job seekers. Given what we have seen regarding compensation at all levels of government, that is easy to believe.
Moreover, a number of studies, including by the OECD and the International Monetary Fund, have shown that countries that balance their budgets through reductions in social transfer programs and the government wage bill -- that is, the number of government workers and the generosity of their pay -- are more successful in reducing government debt than those that raise taxes. The reason may be that, because government pay is among the toughest of expenditures to reduce, governments that succeed in cutting it establish credibility with the public and build confidence with financial markets.
For perhaps the first time, a widespread swath of ordinary Americans appear ready to seriously reconsider the pay, benefits, and job security granted to public employees. With private sector workers and their families bearing the brunt of the recession, the existence of a seemingly protected class of government employees has generated a response that goes well beyond the inefficient use of taxpayer dollars to a sense of fundamental unfairness. But like government largesse in other forms, excessive public pay has some tenacious supporters. Public sector unions, for one, appreciate the extra cash, and even non-union government employees tend to have disproportionate political power. The question of public sector pay will be decided by how Americans vote and, perhaps more importantly, by the courage of public officials after the votes are counted.
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