Bryan Caplan  

Public vs. Private Sector Compensation: A Case of Curious Controversy

Contra Garett Jones: Interest ... In the Land of Interest on Res...
Bewerunge and Rosen's working paper on public- versus private-sector compensation begins with a discussion of recent controversy:
Putting the inflammatory rhetoric aside, much of the debate boils down to the question of whether public and private sector workers receive about the same compensation. As New Jersey Governor Chris Christie expressed it, "at some point, there has to be parity between what is happening in the real world and what is happening in the public-sector world" [2010]. Exploring this issue is challenging for two reasons. First, the human capital of public and private sector workers may differ. If, for example, public sector workers have more education than private sector workers, then it is neither surprising nor objectionable that they earn higher wages. This is precisely the argument made by former White House budget director Peter Orszag regarding federal government compensation: "Basically the entire delta between private sector and public sector federal government average pay can be explained by education and experience...while there may be some remaining disparities, I think some of the more dramatic newspaper stories I've seen about that disparity are somewhat misleading" [Tuutti, 2010]. Indeed, if public sector workers have substantially more education than private sector employees, they might be underpaid compared to what they would earn in the private sector, a point made by Nobel laureate Paul Krugman [2010]: "[T]hose workers aren't overpaid. Federal salaries are, on average, somewhat less than those of private-sector workers with equivalent qualifications" [2010].
Last month, I read most of the academic literature on this topic.  The more I read, the more confused I became.  As far as I could tell, researchers reached a clear answer: federal employees really are paid more than equivalent workers in the private sector.  How then can serious economists debate the issue in the media?

I was pleased, then, to learn that Bewerunge and Rosen share not only my assessment of research on federal pay, but my puzzlement about the controversy.  B&R's on the state of the literature:
The literature on wage differentials between public and private sector employees spans roughly four decades, originating with Smith's [1976a, 1976b, 1977] seminal series of papers. The core of her analysis is the estimation of conventional human capital earnings functions. For example, in Smith [1976b] she uses 1973 Current Population Survey (CPS) data to estimate for each gender a regression of the logarithm of the wage on various worker characteristics such as years of schooling and race, including a series of dichotomous variables indicating whether each individual worked in the federal, state, or local government sectors (the private sector is the omitted category). For males, she finds wage differentials relative to the private sector of 19 percent in federal government and -4.9 percent in local government. The coefficient on the state government variable is statistically insignificant. The differentials for female workers are 31 percent in federal government, 12 percent in state government, and 3.6 percent in local government...

Papers subsequent to Smith's have modified her approach by trying to correct for self-selection of workers into various sectors, by using panel data to estimate fixed effects models, and by estimating models on a state-by-state basis to allow for the possibility that labor market institutions, and hence public sector wage differentials, vary across states. A fair way to summarize the findings in this literature is as follows: a robust result, found in almost all the research from Smith's early papers on, is that there is a substantial positive wage differential for federal employees, even after controlling for worker characteristics in the standard way.
Bewerunge and Rosen's express their puzzlement in a footnote at the end of the preceding sentence:
Hence, the opposite characterization of the literature by Peter Orszag and Paul Krugman (see section 1 above) seems rather curious.
Any charitable explanation for the curious controversy?

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COMMENTS (14 to date)
Emily writes:

There is a branch of the literature - maybe branch is overstating it - which instead of looking at workers and their human capital looks at jobs descriptions. If you look at job descriptions (for instance, field plus GS level or its private equivalent) and you only look at salary rather than benefits, the story changes. This is because of a combination of title inflation in the federal government and federal employees genuinely being given responsibilities that would not be given to someone with the equivalent education/experience in the private sector.

For instance, this refers to an OPM study which found that federal workers earn 22 percent less than their counterparts in the private sector by doing that sort of comparison.

Sean writes:

"... and you only look at salary rather than benefits..."

I don't understand how that can even be done and still get published. The whole appeal of government work is its large pensions and stability; it comes up every time someone discusses working for the gov't. I can understand if the idea is to shoot down the low-hanging-fruit arguments coming from politicians, but it seems unserious.

MCR writes:

How does this literature differ from the comparable worth literature? I don't trust that literature so I am suspicios here.

Unless you compare workers who make the transition into and put of the public sector, can you really establish the claim that public sector employees are over paid?

If you take your doubts about the comparable worth literature and apply them to this one then I am not sure what this literature really shows.

steve writes:

Charitable explanation? No, I can't.

Arthur writes:

Most Krugman's friends have Doctorade, so in his personal experience, public sector pay less.

egd writes:

People like Orszag and Krugman are using their personal experience in government vs. private employment and extrapolating from there.

Both of these two are high-demand and well compensated in the private sector, but chose to spend some time in the public sector. They are paid significantly less for their public work (which may be equally difficult or demanding) than their private sector work, and reason that the result is the same for all public sector employees.

Michael writes:

The best study I have seen on the subject comes from the CBO. They take into account wages, benefits and education. Their conclusion is that Federal employees receive 16% more than comparable workers in the private-sector.

Considering that the average private-sector employee has fallen more than 16% behind productivity gains since 1980, the real problem is underpaid private-sector workers, not overpaid public-sector workers, IMO.

MingoV writes:

The figure of +19% and +31% for male and female federal workers is close to my estimate of +25% (see comment in previous blog post).

The VA hospital I worked at often hired low productivity workers when they were two-fers (usually female African-Americans). We had scads of such employees in clerical positions, food services, and as nursing technicians (an invented position that required no college and had duties similar to that of the Candy Stripers of old).

John B writes:

It wouldn't make sense to say that a PhD flipping burgers at McDonald's deserved to make the same as other PhDs simply because of his educational status. The same standard should apply to government workers. Since the public sector extracts their salaries with coercion, it is possible for the production of many public sector employees to be minimal or even value destructive in contrast to someone who actually does provide demonstrable value like a McDonald's employee.

Seen from the perspective of voluntary transactions, it appears that many government employees should earn negative wages. For instance, I would donate money for the military to stop their murderous drone strikes that are endangering our security here at home. I'd pitch in to stop the Federal Reserve from counterfeiting, the Department of Education to stop preventing private sector provision of education, the Department of Energy to stop interfering with our energy production, etc.

Besides all this, people in the public sector are "serving the public" anyway. They shouldn't be doing it for material gain.

Mike writes:

Orzsag and Krugman aren't stupid, they just lie because they think that we are. That's as charitable as I can get.

Lee B writes:

OK, I'll bite: how can an economist say that millions of people are "over-paid"?

Wouldn't this be the more standard economic story: an employer posts a job description with clearly defined benefits, whatever quality of person those benefits will attract applies, and then (roughly) the best candidate is given the job. You get what you pay for, as they say.

I'm not generally as free-market as you guys, but this paper, the OPM report, etc. all basically seem to using some regressions in Excel to second-guess millions of job-offer decisions mutually made by managers and applicants in a competitive labor market. What would Hayek say?

Full disclosure: I'm a federal employee, who thinks there are tons of problems but this isn't one of them!

David Tufte writes:

I have one possible explanation for your dilemma.

You state that:

... I read most of the academic literature on this topic. The more I read, the more confused I became. As far as I could tell, researchers reached a clear answer: federal employees really are paid more ...

And quote:

... the opposite characterization of the literature by Peter Orszag and Paul Krugman (see section 1 above) seems rather curious.

I think the difference is that Orszag and Krugman are mostly using the non-peer-reviewed media to advance their position. I'm not knocking that.

But, I do think there's a psychological fallacy involved in attaching importance to this. I picked this idea up from Brian Westbury. and it is incorporated in my series "Why Is Macro So Hard" posts on voluntaryXchange, and the associated lectures.

The issue is that the legacy media strive for "balance". What they mean by that is that producers will work behind the scenes (like the proverbial duck on a pond) to make sure they present 2 opposing viewpoints. What they do not tell you is how much effort they went through to find those 2 viewpoints. It's quite possible that the first person they called agreed to represent the first viewpoint, but they had to call a hundred people before getting anyone to agree to represent the second viewpoint. But all of that is water under the bridge: now they present both viewpoints as if they are equal, when they are not.

To stretch that even further, there may be monetary gain to willingness to publicly represent unusual or unpopular viewpoints. I like and respect both Krugman and Orszag, but I have no doubts that 1) they are making much more money than I am in our second jobs as a public intellectuals (rather than just as academics), and 2) that I don't have the stomach for making the claims that they do.

John writes:

I don't see why we should pay anyone more merely because of education. That seems wrong -- reward for any job should be for performance in the job and the value output from the job.

I do realize the education levels are required in public positions to get certain pay grades but that's not quite true in private work -- yes, yes, yes, college to get a job and grad degrees also offer differential but once in the company performance will generally trump wall paper for promotions.

I think it would be interesting to see what the results are if you ignore education in the models.

TomB writes:

A lot of government workers get masters degrees because many positions will pay more, for the same job, if the person has a masters degree. So they go to some local DC institution for a year to two years part time, get a masters degree in "Security Studies" or some malarkey, and then presto, get a salary increase. For the most part, these aren't rigorous degree programs. But through the magic of aggregate comparisons, a masters degree in security studies from University MD University College is treated the same as a masters in accounting from Wharton.

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