The Public-Private Wage Gap, Part II

Posted by Nolan Miller on Jul 7, 2010

Filed Under (Uncategorized)

This week, I’m following up on my earlier post regarding the gap between the wages earned by public and private sector workers.  Given the financial problems faced by state and local governments across the country, the idea that overpaid public employees are, in part, responsible for these problems (and that, by extension, lowering their compensation should play a part in solving the problems) has gotten a lot of attention lately.  However, the best evidence we have on the point, not to mention common sense, suggests that the main factual claim underlying this argument – that state and local employees are overpaid on average – is wrong.

The issue of comparing wages across sectors is complicated.  Fortunately, a recent report from the National Institute on Retirement Security provides a nice introduction to the difficulties of the analysis and a comparison of the compensation earned by state/local workers to that of the private sector that paints a very different picture than the one that has been in the newspapers lately.  To be sure, the NIRS study is not without a point of view, and I think that the analysis is off in places, but it is certainly closer to correct than the naïve figures driving the headlines.

First and foremost, we must recognize that government jobs are different than private sector jobs and government workers are different than private sector workers.  In many cases, public jobs (e.g., police, fire fighters) have no private counterparts and vice versa. It is impossible to compare what a police officer earns in the public and private sectors, since there are no private police officers.  In addition, even when jobs have the same basic title, government jobs often have very different responsibilities than their private sector counterparts.  This results in, for example, almost 54% of state and local workers having college degrees, compared to only about 28% in the private sector.

These differences suggest that comparing average wages across sectors, as is done in the USAToday and BLS studies I cited last time, is likely to get the answer wrong due to differences in the composition of the two workforces.  An alternative approach, and the one that is used in the NIRS study, asks the question “given a person’s age, education, experience and other demographic factors, how much more would he or she be paid in the private sector than he would be paid in the public sector?”  Using this “people-based” approach, the analysis comes up with the answer that a typical public employee’s wage is about 11% lower than it would be if that person were employed in the private sector, reversing the basic finding of the newspaper analysis.  (In Illinois, the difference is more like 12 – 13%.)  Even when the study takes into account that public sector employees earn more in benefits than private workers, the gap is still about 7%.  So, the study’s basic finding is that state/local employees have, on average, lower total compensation than private-sector workers.

The NIRS study does a lot to dispel the idea that average state/local employees are earning more than they would in the private sector – getting fat off the taxpayer, as it were.  However, it is not without problems of its own.  The first, which the paper recognizes in a technical appendix, is that the analysis should also take into account that the mix of jobs done by state/local workers differs from that of the private sector.  Controlling for this shrinks the wage gap somewhat.  The second, which Jeff has written about, is that typical government accounting methods undervalue benefits, in particular they undervalue pension benefits.  Properly valuing pensions would further erode the gap.  In the end, I suspect that the gap between state/local (and federal for that matter) workers and private sector workers is quite small and is not systematically either positive or negative.  In other words, markets probably get things about right.

As a final note, here are a couple of economist “smell tests” for wages.  First, when our department tries to hire someone, we are competing against other public and private employers.  When we succeed in hiring someone, we have negotiated to the point where they are willing to accept our offer when compared to their alternatives.  So, almost by definition, the value they place on total compensation at the two places (relative to the demands of the job) should be pretty close.  Of course, since they chose to come here, they must like our packages somewhat better, but if we did a decent job of negotiating, not too much better.  Second, if total compensation in the government sector is systematically higher or lower than those of the private sector, we should see massive flows of workers in one direction or the other.  The fact that we don’t see this suggests that people are, by and large, happy with the jobs they have.  This, again, suggests that the market has wages about right.