Out of Balance, or Out of Proportion?

A new look at whether public employees are overpaid.
by | May 6, 2010

A recent study sheds new light on the nagging question of whether public employees are paid too much relative to their counterparts in the private sector. The study, which is making the rounds in public management circles, was sponsored by the National Institute for Retirement Security, a public-pension advocacy group, and by the Center for State and Local Government Excellence, which obviously sees virtue in the public sector. Both organizations are unabashed in their commitments to public service. As long as everybody checks out the funding sources, we can take their duly selective research reports with an appropriate grain of salt.

If you ask the typical business economist, such as Gary Shilling (whose recent Wall Street Journal editorial addressed this same issue with a jaundiced eye), you generally will hear that the Bureau of Labor Statistics (BLS) data show public employees getting paid much higher than private employees. When you then add the richer benefits packages that public employees typically receive, the traditional conclusion of the less-government crowd has been that public employees have too sweet a deal.

So along came two professors, Ken Bender and John Haywood of the University of Wisconsin-Milwaukee, with a different and clever new cut of the data. They broke down the BLS data by occupation and then stratified it by educational level. When viewed that way, they found that public employees are often better educated than their private-sector counterparts in similar occupations. For example, most police officers today are better educated than private security guards and night watchmen. So when educational factors and other potentially relevant correlates like work experience are controlled, they found that public employees are not paid more than non-governmental workers, even when richer benefits are added to the mix.

Their research aligns with the everyday experience of most of us who work in and around the public sector, where the folklore is that many but not all governmental jobs do indeed pay lower salaries than private employers. In professions such as public health, engineering, law, finance and management, few would dispute that public-sector pay is lower. Emergency room doctors at the county general hospital usually make less than private practitioners (unless they are TV stars). Teachers have traditionally received lower salaries than many other college graduates — along with longer vacations, summers off and better benefits. And the idea that benefits are richer for most public employees is no surprise to anybody either. Nor is the observation that tenured public employees are paid more than younger workers. So, a study that controls for "work experience" will tilt results favorably for unionized and seniority-based government-employee pay plans.

After all, we would expect a teacher with a master's degree and a police officer with a criminal justice degree to be paid more than a gardener, a dog groomer or the kids flipping burgers at Mickey D's. Of course, the ratio of burger-flippers and domestic workers seems to grow faster in the private sector than similar unskilled employment in the public sector as the economy sheds skilled manufacturing jobs and employs more lower-skilled service workers. That structural shift in the mainstream economy is not addressed by this report. Nor is the last decade's impact of technology (think Microsoft Office and the mechanization of public works) in the public sector's low-skill sectors relative to the private services economy.

The report goes on to claim that public employee compensation with all these factors held constant has not grown faster than private employees in the past decade or more. This will be harder for many objective readers to swallow as a genuine fact and not the result of statistical maneuvering. Maybe it was all those realtors, homebuilders and investment managers who skewed the 2008 data for private compensation. Or perhaps the statistical result reflects a doubling of the percentage of public employees with college degrees during the study period, which would skew results when used as a control factor.

Flaws aside, I want to applaud the efforts of the sponsors and the researchers for a valiant first effort. They have shed some needed light on an important topic. Whatever one's biases, for or against prevailing public-sector compensation levels, this kind of analysis is instructive. In the search for the truth, we're actually getting somewhere here.

The report fails to make an airtight case, however. To drill deeper, I fired off a half-dozen questions to the researchers, who were prompt and plausible in their responses -- which heightens their credibility overall. First, I discovered upon inquiry that approximately one-half of the college-educated public workers were educators. Thus, this study is skewed by the compensation practices in the school systems, and it comes as no surprise that teachers have been paid less than other college graduates in the private economy for a host of reasons. It would have been nice to see if the same conclusions would result for the remaining governmental employees. Otherwise, we may infer conclusions about teachers that don't apply to public safety and public works employees, office clerks and mid-level bureaucrats.

Second, they massaged the BLS data to derive hourly pay rates, using assumptions rather than facts on overtime and actual workweek levels. Now, it may very well turn out that there's no statistical difference if you were to compare actual W-2 income, but common sense and 30 years of experience around the public sector tells me that many highly unionized public employees (by a ratio of 4-to-1 over private workers) are probably collecting more overtime pay with their college degrees than nonunion degreed professionals who are treated as exempt elsewhere.

Just take the case of those police officers with their criminal justice degrees. They rack up big-time OT with their criminal justice degrees. And most local-government managers privately complain about firefighters, who clearly get paid more than anybody you'll meet with comparable education levels -- and receive big pay premiums for seniority and specializations (treated here as "work experience"). At the lower skill levels, however, I would agree with the researchers that overtime would likely be more prevalent in the private sector, so it's a mixed bag depending on one's focus. Their reply to me was that statistically, overtime is a relatively minor element of overall compensation, so perhaps it machts nichts (doesn't matter) in the grander scheme of things.

Third, the researchers conclude that public employee benefits are only marginally higher than private counterparts, whereas economist Gary Shilling cites BLS data showing public sector health benefits costs to be double those in the private sector. This report instead jump-shifts from its primary methodology for wages to other statistics to draw global inferences regarding benefits as a percent of total compensation, and abandoned the researchers' sharper analytic tools when it came to benefits. I will leave it to the research community to determine if there is a more consistent way to evaluate the available data.

Fourth, in an important omission, the study ignores the unfunded but real, imminent cost of public employee retirement benefits such as retiree medical benefits because these data are not reported to the statistical bureaus. Thus, they overlook a highly valuable retiree medical benefit because it's unfunded. The same is true for unfunded pension costs that have now doubled because of 2000-2008 investment underperformance and a 20-year trend toward earlier retirement ages in some states (despite increases in life expectancy). So the taxpayers are on the hook for much higher benefits costs than the researcher's models have acknowledged. Those deferred bills will come due, but they are ignored in this study. The private sector provides little-to-no retiree medical benefits, and has largely shifted from defined benefit pension plans to 401k plans that avoid unfunded liabilities. Given today's $2 trillion of non-amortizing retirement plan deficits in our sector, my estimate is that their error of omission here is in the order of magnitude of 5 to 10 percent of public-sector base pay on average nationwide, judging anecdotally from the dozens of recent actuarial reports I encounter in my day job.

Whether this is significant enough to make a fuss about it is up to the reader. I just want to point out some weaknesses in the methodology that would be nice to see remedied in future research along these lines. Certainly the data here would not be sufficient to justify or rationalize earlier governmental retirement ages that haven't been paid for and aren't reflected in the reported costs.

I asked the researchers about the unionization factor, and they informed me that it was used as a control factor in the regression analysis. If public employees are unionized by a 4-to-1 ratio vs. the private sector, then my instinct tells me there is a material impact here that gets lost in translation. If there is a different correlation between unionization and college degrees (taking teachers and police officers again as prominent examples) between the two sectors, then we need to think more deeply than this study has gone. From a public policy standpoint, unionization as a driver of compensation costs is hardly a neutral or benign variable.

The most troubling aspect of the report may be an underlying tone of elitism in the presentation of some pretty rigorous statistical work. The sponsors' press releases and executive summaries hinted of a self-righteousness from partisans who justify pay levels on the basis of their credentials. If the conclusion is that teachers receive lower pay relative to their education levels, I would have no quibble, but we need to be careful about inferences in other sectors of government. Meritocracy-by-diploma has its place, but it has the downside of an entitlement mentality.

This is not to suggest that we want dumber public servants, or to challenge the value of trained public employees and administrators. The alternative of underqualified, ridiculously underpaid civil servants would be a huge step backward for American society. I personally have invested six-figures' worth of my own money to sponsor a scholarship program so that worthy graduate students in public finance can afford to get their degrees to work in government for inferior pay without taking on huge student loans -- my payback for an opportunity I was given in 1972 that I have never forgotten. I just don't want to see a study like this used to advance a new-age Plato-Republican entitlement concept of Philosopher-Kings who somehow justify cushy paychecks and six-figure pensions simply on the basis of their masters' degrees. That kind of elitism will quickly backfire on the entire public sector in the form of citizen backlash as witnessed in a recent "Saturday Night Live" sketch that degraded public employment. Humility will be very important during these tough times. Those who expect pay parity with the private sector -- and better benefits and earlier retirements -- are heading for a clash with voters.

Everybody seeking budget reductions or constructive change in the public sector through realignment of employee compensation and benefits should read this report carefully. Professors Bender and Haywood did some solid research here and dispelled a prevalent myth. They have shown quite clearly that the public-private pay gap is certainly not what it seems on the surface -- although we need to be careful not to over-generalize in the other direction now. But whatever its limitations, the study provides worthwhile insights and a foundation for a more intelligent dialogue. If it spawns another round of even better focused research, that could improve governmental decisionmaking -- as public-employee compensation and benefits policies are run through the wringer in the lean years still ahead.

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