Public v. Private Sector TOTAL Compensation ... How Fair and How is It Determined

 Overview

There is a big difference between the absolute need for continuous and rapid improvements in private sector productivity and the general lack of any productivity gains in the public sector.

In my opinion, the difference in productivity gains between the private and public sectors is attributable to the system, and is not the result of the different capabilities of those individuals who work in the different sectors.

For example, earning an adequate profit for the company's investors is the fundamental cost of staying in business in the private sector. Accordingly, in the private sector the need to generate profits serves as a lid on uncontrolled compensation and other costs relative to prices. It's a price based costing world and if prices are too high relative to competition, the company goes bankrupt over time.

However, no such need for profitability exists in the non-price based costing model followed by the monopolistic public sector. There's no need to make profits, so there's no effective constraint on costs, including compensation. It's really that simple.

The system of capitalism, aka private sector competition, is all about disruptive market based competition --- improving upon the status quo by destroying the old way of doing things, taking risks, innovating and pursuing entrepreneurial endeavors. As opposed to merely working in the existing system, private sector leadership is required to contnuously work on the system to make beneficial changes to lower costs and improve the value of the goods and services offered for sale.

On the other hand, public sector employees work in a monopolistic and risk averse system where disruptive change is resisted and preserving the status quo is the main objective in the work place. Accordingly, risk taking, innovation and productivity enhancing entrepreneurial efforts are largely missing in the public arena. It's the way the system works.

Comparing Private and Public Sector TOTAL Compensation, Including Benefits and Job Security

So now let's turn to the relative pay practices between employees who work in the private and public sectors, respectively. We'll take a crack at what's "fair" TOTAL COMPENSATION for employees, customers and taxpayers.

When the free market establishes pay levels, determining what's fair and affordable pay is relatively easy. The "invisible hand" of the market takes care of that. If we pay too much, we go broke. If we pay too little, nobody works for us.

It's the same thing for a self employed individual. His time is worth whatever someone else is willing to pay him for doing what he does. Is it fair for rock stars, actors and professional atheletes to make the kind of money they do? Absolutely. Otherwise the customers wouldn't agree to pay those sums to see them perform. To repeat, that's the "invisibile hand" of the free market at work.

But what about government employees who work in a monopoly? Or even private sector workers who are represented by unions? Well, their pay is obviously arbitrary and not market based --- perhaps arbitrarily low or perhaps arbitrarily high --- but nevertheless arbitrary. The market's role is at best indirect.

And that brings us to average pay. A long time ago, someone explained averages to me in the following manner . If there are two of us standing in a room and one stands aside while the other has one hand on a burning stove and one foot in a freezer, both may experience average temperatures, but they certainly don't feel the same way. Get the point?

Why do workers who toil for the monopolistic government get paid by averages based on the number of degrees awarded, length of service and so forth?  Because it's easier to do it that way, I suspect, even if it's totally unfair to the top performers and a wrongheaded negative performance subsidy for the low performers.

For Federal Workers, the Grass Isn't Greener in the Private Sector tackles the issue of relative pay 'fairness' in the public and private sectors, including teaching:

"If public employees are underpaid, they ought to get raises when they switch to the private sector. But they don't, and that fact is telling.

Debates over compensation for public employees have raged at all levels of government over the past few years. The Federal Salary Council, an official advisory body, claimed in October that federal employees are paid only 65 cents for each dollar earned by workers in comparable jobs outside the federal government.

Federal workers would seem to be drastically underpaid, based on the council's numbers. But what does it really mean for public employees to be "underpaid" or "overpaid"?

Here's one way to think about it: If a worker is overpaid, he'd probably receive lower pay from most other employers. Likewise, an underpaid worker should be able to get a raise by performing similar work for a different employer. . . .

Analyzing how salaries for the same workers change as they shift between jobs in the public and private sectors automatically controls for worker traits that aren't directly measured in most datasets – traits such as intelligence, motivation and creativity. Only the job changes in these comparisons; the worker stays the same.

The Census Bureau tracks tens of thousands of households over several years in its Survey of Income and Program Participation (SIPP). Many workers in these households switch jobs during this time, allowing us to observe how workers' salaries rise or fall as they change jobs.

So what can applying this job-switching test to the SIPP data tell us about public employee pay? Keep in mind that the Federal Salary Council's numbers imply that in taking a job outside government, the average federal employee would receive a staggering 54 percent increase in salary. In the real world, though, the data show that most federal workers looking to cash in by leaving will end up disappointed.

According to the SIPP data, the average federal worker shifting to a private job actually accepts a small salary reduction of around 3 percent. Similarly, private sector workers who move to federal jobs don't take a pay cut. They get a first-year raise averaging 9 percent, well above the raise other workers get when they switch jobs within the private sector.

In short, there's real-world evidence that federal salaries are at least equal to private-sector salaries for workers with the same skills.

Now consider the state and local levels. If any group of public workers is underpaid, conventional wisdom suggests it would be schoolteachers. . . .

Not so. Nationwide, non-teachers who move into teaching receive an average raise of around 8 percent, according to SIPP data, while teachers who leave the profession take an average salary cut of around 3 percent. . . .

Of course, it's possible that the public employees who move to the private sector are among the least-skilled workers, helping to explain why they don't receive big pay increases. Even if this is the case, however, it implies that the most skilled government workers don't require a salary increase -- since they don't leave their jobs in the first place. . . .

Importantly, none of the tracked changes in salary after job switches takes into account the job-to-job changes in fringe benefits. Most public employees have guaranteed pensions and retiree health coverage, both of which are increasingly rare in the private sector.

In a competitive labor market, superior benefits should allow governments to offer lower salaries while continuing to attract and retain employees. But the evidence indicates that government salaries alone are comparable to, and often more generous than, those in the private sector.

Many public employees honestly believe that they could earn much more in the private sector. As it happens, though, few actually do. With federal, state and local governments paying out almost $1.5 trillion in employee compensation in 2012, this isn't a trivial fact."

Summing Up

When markets set pay, there's automatic "fairness."  Accordingly, when governments arbitrarily establish pay levels, there's no such objective "market check" on the pay scales.

And when public employees enjoy greater job security and more generous benefits than do their private sector counterparts, logic dictates that their direct compensation should be markedly lower than what's being paid for comparable work in the private sector.

But that's not what's happening. In fact, that's almost always not the case.

My take is that the pay and benefit levels for public workers should be set at much lower rates than that enjoyed by their private sector counterparts.

Then if the taxpayer supported public employee isn't satisfied with his pay level, let him enter the free market. And if a whole bunch of public employees immediately bolt for the private sector, then the taxpayer can be expected to willingly adjust public sector pay levels upward. If not, all's well.

It could be that simple, my fellow taxpayers. But the public sector unions and lots of government officials wouldn't like such a common sense approach one little bit.

Maybe that in itself makes it a very good idea and one worth trying.

Thanks. Bob.