Last week I attended an engrossing two-day conference hosted by the Searle Center at Northwestern Law School on Government Unions in the United States. Scholars from economics, finance, law, and political science presented their research on an number of different dimensions of this theme.
One question that received a great deal of attention was whether public sector employees are compensated more generously than private sector employees with similar skills and engaging in similar tasks. This is a difficult question for two reasons. First, it is challenging to obtain comparability across individuals and jobs. Many public sector jobs have no private sector equivalent. Second, it is widely agreed that public sector accounting does not accurately represent the value of the benefits that public employees receive.
Presenters reviewed existing research and provided their own evidence. Essentially everyone who looked at the data found that public sector workers on average have slightly lower salaries. The contention was over whether higher public sector benefits more than offset this wage differential in total compensation. My own research with Robert Novy-Marx translates public sector pension costs from accounting where new benefits are discounted at 8% to accounting where new benefits are discounted at a rate that represents the liability as a promise that is invariant to asset returns. This reveals that pension benefits are around 15% of pay more expensive on average than is recognized. Conference participant Andrew Biggs argued that the differences are even larger.
Even going with our lower number, 15% of pay is larger than the public-private salary differential that are found in the data. That suggests to me that total compensation for an average public sector employee might be somewhat higher than that for a private sector employee whom these studies characterize as having comparable individual and job characteristics. I am, however, skeptical that comparability of individual and job characteristics in the public and private sector has been or really can ever be achieved. Attempting to benchmark the compensation of, say, public safety officials to private sector employees is obviously problematic. In such a case, the appropriate level of pay is simply whatever the employers and employees can agree upon – but that only leads to efficient outcomes if there is transparency about the public sector compensation packages that allows all parties, including taxpayers, to understand the value of the benefits. That transparency is currently lacking.
A related question at the conference was whether public sector collective bargaining and public sector unionization actually succeed in raising compensation. Here there was in fact no conclusive evidence. A number of speakers noted that it is possible for workers to be unionized but lack collective bargaining rights. Neither collective bargaining nor unionization seemed strongly correlated with compensation in the studies that were presented — although it is impossible in this setting to have counterfactuals (that is, to know what a given public sector employee would have earned in the absence of the union’s influence).
This all suggests that public sector unions may not be very effective at raising compensation on a case-by-case basis. But one role they clearly have played as a group is to resist measures that would bring the true costs of public sector benefits to light. Currently these costs are concealed from the public by the flawed economics of the Government Accounting Standards Board (GASB) methods. And public sector unions are clearly not in favor of changing these standards, as revealed for example by their opposition to the Public Employee Pension Transparency Act.
For the very reason that many public sector jobs have no private sector counterpart, transparency in public sector benefit costs is essential. Public sector unions could probably gain support with the public if they stopped defending the lack of transparency in public sector accounting.
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With regard to the value of pension benefits from the employees’ perspective, the difference in our numbers may come from how they are being calculated. It’s possible that you may be converting the employer’s normal cost (that is, the cost of accruing benefits) under an 8% discount rate to that under a risk-adjusted rate (say, 4%). We take the total normal cost (which is generally the employer normal cost plus the employee contribution), adjust it to a risk-adjusted discount rate, then subtract the employee contribution. This reflects the fact that a public sector DB plan effectively pays the participant an 8% average return on both his and his employer’s contributions. On the other hand, there may be differences simply based on the data that we use. We worked from Florida data; Washington State also releases some data which produce similar results. The age structure of the plans will influence the effects of changing the discount rate (if it’s a new plan with younger participants, lowering the discount rate has a larger effect on the normal cost).
You’re right that jobs like public safety are tricky; presumably there’s a compensating wage differential for job risk. That said, the typical public safety pension plan is REALLY generous, particularly when measured on a market basis. I suspect that even if we pulled police/fire from our samples we’d still get a total compensation premium.
Finally, wage comparisons are tricky because of unobserved productivity differences that usual measures of education and experience don’t catch. But we’ve also used a fixed effects model that accounts for these and the salary results are pretty similar, so I think the cross sectional regressions do a decent job in this case.
[…] Here's another round in the never-ending attempt to compare compensation for public and private employees. The comparison could be more complicated than rocket science, and any effort to explain it is near heroic. But this comparison, done by Josh Rauh of the Kellogg School of Management does make one important point: This all suggests that public sector unions may not be very effective at raising compensation on a case-by-case basis. But one role they clearly have played as a group is to resist measures that would bring the true costs of public sector benefits to light. Currently these costs are concealed from the public by the flawed economics of the Government Accounting Standards Board (GASB) methods. And public sector unions are clearly not in favor of changing these standards, as revealed for example by their opposition to the Public Employee Pension Transparency Act. […]
Your analysis left at least two things out of great significance. First, the ability of public sector unions to engage in political activity provides them a unique advantages not available in the private sector – they negotiate with the bosses they elect, and when they negotiate higher compensation the “company” is not put out of business by uncompetitive costs, instead the agencies simply raise tax revenue. Second, to get at whether or not public safety personnel are overcompensated or not, you might have reviewed compensation trends for public safety personnel (and all government personnel for that matter) over time. When you compare the change in pay scales, adjusting for inflation, over the past decade or two, you will see a clear shift, whereby public sector compensation has consistently exceeded the rate of inflation, at the same time as private sector compensation has failed to even keep pace with inflation. Here is a recent study, referencing source data, that shows that in California over the past 10 years, the average firefighter’s compensation by 33%, AFTER adjusting for inflation:
http://unionwatch.org/californias-public-safety-compensation-trends-2000-2010/
[…] Last week I attended an engrossing two-day conference hosted by the Searle Center at Northwestern Law School on Government Unions in the United States. Scholars from economics, finance, law, and political science presented their research on an number of different dimensions of this theme. One question that received a great deal of attention was whether […] Everything Finance […]
The comparisons outlined omit another dimension that seems to be consistently overlooked. As a retired economist, I am always a bit surprised by the persistent omission of an important factor. This is the disregard of huge difference in ‘lay-off’ risk between employment in the public and private sectors.
This is the equivalent of credit risk in investing in bonds. US Government bonds return less because there is essentially zero risk of default. Greater safety involves a trade-off for lower returns. The risk spread quite substantial. Even though there have been some lay-offs in the public sector over the past couple of years, their magnitude is trivial in comparison with the carnage in the private sector. Plus in the public sector, stringent seniority rules put most of the risk on new relatively low-paid hires like untenured teachers, further insulating most employees from risk.
When investing one’s human capital in a career path, the security of employment is the equivalent of credit risk. Accordingly, the relevant comparison in the public vs. private sector analysis is not just the total compensation package but the risk-adjusted total compensation package.
I certainly do not think that new teachers are overpaid — they are the sacrificial goats for poor past employment practices. Still, public sector employees have to realize that voters will be increasingly unwilling to fund compensation and employment stability that is clearly better than they can usually achieve themselves.