Allison Schrager writes

. . . people must rethink the social contract between state workers and taxpayers. As health care gets more expensive and people live longer, the old model simply isn’t sustainable. This means that either benefits must be cut (which, given legal hurdles, is unlikely) or state residents must pay more taxes.

An issue I have with the popular discussion of public sector pay and unionization is that on all sides there is a temptation to frame this as a moral question. What are worker’s rights? What are tax payer’s rights. What is the social contract and is one group cheating the other.

Some of this is unavoidable since public sector pay is influenced by the democratic process. Still we should not encourage it.

The public sector isn’t a stage on which to air our perceptions of the just society, either from the point of view of workers or tax payers. The public sector is a labor market.

In a labor market the greater the total value of the compensation offered the greater the size of the applicant pool. The question facing policy makers is at its heart, do we have too many applicants or not enough? Are our best applicants over qualified or under qualified?

If they are over qualified then you are paying too much. This is bad, but not primarily because it raises costs for tax payers. Obviously tax payers would prefer to pay less, but so would any customer for any service.

If the tax payer is buying a higher quality service than he or she needs then the problem is that we are wasting human talent. That public sector worker could be employed somewhere else in the economy and produce more value there.

On the other hand if public sector workers are under qualified then they are being paid to little. Again this is bad but not primarily because the workers are getting too little pay. All workers, public and private would prefer to be paid more.

It’s a problem because there are workers somewhere out in the private sector who could be creating more value as a public sector worker. This may strike some more libertarian readers as crazy. Yet, consider the following simplistic example.

A talented driver might face a choice of whether to  to drive a fire engine or drive a tractor trailer. Both involve a special set of skills that is rewarded by higher pay. It could be the case that human welfare is higher if the best drivers all drove private tractor trailers, but this is not obviously the case. There is a lot on the line in getting a fire engine to a fire quickly and safely. Having the worst or even a mediocre set of drivers could easily be more costly to the public than offering higher pay.

Now, we might imagine that this simplistic analysis is mucked up by the presence of labor unions and public pay scales. Some of this is possible if the union prevents the firing of certain workers or doesn’t allow differences in pay based on differences in ability.

Simply driving up the salaries and benefits for public sector workers, however, will not cause basic labor market mechanics to collapse. This generates inefficiencies but the basic forces of supply and demand still assert themselves. We still have an upward slopping labor supply curve and unless the union is actively keeping people out, that doesn’t change at all.

Unlike in a private firm there is no profit maximizing relationship that matches labor demand to the marginal benefit of customers. This implies that there is no force to mitigate inefficiencies on the customer side. It doesn’t change the nature of the inefficiencies emanating from the labor market, though. Either the workers will have pay in excess of the marginal benefit of quality or the marginal benefit of quality will be in excess of pay.

In a private market the very same inefficiencies would occur. Constriction on the supply of workers would drive up the wage which would drive up prices for customers. The customers would respond by buying less and that would mitigate the inefficiency to some extent. Yet the failure in the labor market would be the same, the bar for quality is set too high.

We shouldn’t think that simply because public workers are employed by the government that the basic rules of supply and demand fall apart. Labor supply curves still slope upward and the quality of workers will still be a function of their compensation. 

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