Are Public Sector Workers Overpaid?  The Story of Underfunded Pensions

There has been a serious effort by many on the right to claim that public sector workers are overpaid.  The typical way that critics make this argument is to simply compare the average wage of workers in the public sector and the private sector.  This comparison does indeed show that public sector workers are paid more than private sector workers.

However, this comparison is highly misleading, as any serious analyst would quickly acknowledge.  Public sector workers on average have more on-the-job experience and are far more likely to have college degrees (think teachers and nurses) than the workforce as a whole.  Several analyses have compared the pay of public sector workers with their private sector counterparts and found that private sector workers actually enjoy a small pay premium.  (For example, see the studies from the Center on State and Local Government Excellence, the Center for Economic and Policy Research, and the Economic Policy Institute.)

Andrew Biggs, an economist at the American Enterprise Institute, has responded to these studies by arguing that public sector workers are still overpaid, if we properly account for the cost of public sector pensions.  Biggs argues that these studies failed to note that public pension funds currently have large shortfalls.  This means that current contributions for pensions, which were used in the recent comparisons of public and private sector compensation mentioned above, are the inappropriate measure.

Biggs argues that an accurate analysis would include the additional contributions needed to make up the pension shortfalls.  In the case of the state of California’s pension funds, which have one of the largest shortfalls, Biggs calculates that factoring in the underfunding of the pension would increase a 2 percent wage premium for public sector workers to a 10 percent premium.

But, there is a serious problem with this analysis.  The main reason that public pensions are underfunded is not that states have grossly underpaid for their workers’ pensions.  Rather, the problem is that state and local pension funds got zapped by the stock market plunge and the economic crisis.  If state and local pension assets had grown at just a 5.0 percent nominal rate (modest by historical standards) from their levels at the end of 2007, they would stand at more than 3.6 trillion today, 41.3 percent above their actual level at the end of the second quarter of 2010.  This would leave the pension funds close to being fully funded.

In short, pensions are facing shortfalls today because they were hit by bad luck.  We can ask why the pension funds were so foolish as to not recognize the risks of investing with Wall Street.  For what it is worth, some of us did try to warn them.  But, this bad luck has nothing to do with the workers’ pay.  It is like saying that a cancer patient is overpaid because his employer-paid health insurance plan spends lots of money on cancer treatment.  The issue is not the actual payment for the specific worker’s health care.  The relevant question is how much should we have reasonably expected pensions to cost the government.  By this measure, the state contributions are a reasonably good estimate.

So, this boils down to yet another case of the Wall Street crew trying to use the disaster that they themselves generated to force cutbacks in the living standards of ordinary workers.  File it under “what did you expect?”

Dean Baker is an economist and Co-director of the Center for Economic and Policy Research, in Washington, D.C.  This article was first published in CEPR’s blog on 11 November 2010 under a Creative Commons license.

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