From the Public Sector

Michael Mandell provides a nice illustration regarding public and private sector compensation:

The chart shows that public and private sector pay rose in parallel from 2001 to 2004. Then the lines diverged. Since early 2005, public sector pay has risen by 5% in real terms. Meanwhile, private sector pay has been flat.

Now, I don’t begrudge people getting raises, or extra compensation. However, sticky wages and prices are the driver of recessions, and especially in monetary disequilibrium. We are currently roughly 8% below the previous long-run trend in NGDP growth. What this means is that roughly $1.3 trillion dollars will not be generated by our economy this year (unless we have speedier M*V!).

Unfortunately state workers aren’t exempt from the physical properties of market economies. Because state workers — along with all workers — aren’t very happy to see their pay cut, they are causing a severe disconnect between their real productivity and their real wage, and ruining government finances in the process.

In the private sector, the problem of sticky wages is circumvented by layoffs. The problem in the public sector, of course, is that there is a monopsony buyer of labor. As I have explained in a previous post, when a monopsony buyer is present, it is almost assured that sellers will organize into a monopoly…and that theory bears out with the government being the most unionized sector of the economy.

In reality states probably didn’t need stimulus money (or as much stimulus money) in order to keep functioning, they needed stimulus money to paper over the ~13% real wage increase enjoyed by public sector employees. If nominal wages are 5% higher than they “should” be in the public sector, that amounts to about $50 billion per state. Not coincidentally, state budget gaps average about $55 billion.

I suppose we shouldn’t be hearing about Herbert Hoover anymore.


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