A Decade of State and Local Gov’t Stagnation

First, a confession. If I was any good at marketing, I wouldn’t be putting up this post on the Wednesday before Thanksgiving, when everyone is more concerned with turkey and traffic than the state of the economy.

But I can’t help myself–I’ve just got to share this chart.

This chart shows that real state and local government output, as measured by the BEA, has been effectively flat since 2001. To put it a different way, the stagnation at the state and local government level started way before the 2007 recession.

What do I make of this? State and local governments are the only large economic entities in the U.S. economy who are not allowed to borrow to meet operating expenses. Households can borrow, companies can borrow, the federal government can borrow–but state and local governments cannot. (Added:State and local governments accounted for only 7% of the rise in domestic nonfinancial debt between 2000 and 2010).

Therefore they have been forced to match their size to the carrying capacity of the individual state and local economies. Hence we see the epic struggle of states such as California to trim their budgets and labor force.

In other words, the state and local fiscal crisis is less a failure of governance (though such obviously exists) and more a sign of weakness in the individual state and local economies going back a decade.

Added: Real state and local output includes investment spending and compensation for state and local employees, adjusted for price changes. It does not include most Medicaid spending (which shows up in personal consumption) and some other small categories of social benefits, such as workers compensation.

One View of State Budgets and Higher Education

I start out with the belief that investment in higher education is in general a good thing. However, I’ve been worried by the decline in real college grad wages.

 I came upon this 2009 Brookings paper, “The Causal Impact of Education on Economic Growth:Evidence from U.S.”, by P. Aghion , L. Boustan , C. Hoxby, and J. Vandenbussche. Let me take two excerpts from the beginning and end of the paper: 

Should countries or regions (generically, “states”) invest more in education to promote economic growth? Policy makers often assert that if their state spends more on educating its population, incomes will grow sufficiently to more than recover the investment.

 //giant snip//

We find support for the hypothesis that some investments in education raise growth. For the U.S., where all states are fairly close to the world’s technological frontier, we find positive growth effects of exogenous shocks to investments in four-year college education, for all states. We do not find that exogenous shocks to investment in two-year college education increase growth.

This suggests that the money would used equally productively elsewhere. We find that exogenous shocks to research-type education have positive growth effects only in states fairly close to the technological frontier. In part, this is because research-type investment shocks induce the beneficiaries of such education to migrate to close-to-the frontier states from far-from-the-frontier states. Put another way, Massachusetts, California, or New Jersey may benefit more from an investment in Mississippi’s research universities than Mississippi does. Finally, we show that innovation is a very plausible channel for externalities from research and four-year college type education. Exogenous investments in both types of education increase patenting of inventions.

What conclusion should I draw from this paper?  Should we put more money into research-related education spending and four-year schools, and less into two-year colleges? Or are we missing something important here?

The End of the Fiscal Stimulus?

Did the first quarter mark the end of the fiscal stimulus?  And will it be enough to work?

People are always trying to judge the fiscal stimulus by whether it creates jobs.  But that was never the real justification for spending all that money.  The theory was that the economy has multiple equilibria–a good equilibrium where everyone is optimistic about the future,  companies invest, and households spend, and a bad equilibrium where everyone is  locked into a mutually reinforcing gloom about the future.  Then a big enough fiscal stimulus can forcibly kick the economy from the bad equilibrium to the good equilibrium.

The key term here is ‘big enough’.  I think of the stimulus as a big booster rocket for the economy. If the rocket is strong enough, it can put a satellite (the economy)  into a stable orbit. Not enough boost,  jobs are created by spending money, but the economy falls back to earth again once the stimulus stops (wow, that was a mixed metaphor, but I’m good with it).  

By this measure, the stimulus can only be judged successful or not after it stops firing.  Or to put it another way, we want to see if the private sector  continues to grow once the government stimulus is removed.

As it looks like tht critical moment has arrived.   Based on the latest BEA data,  the stimulus ran out of fuel in the first quarter, and we’re about to find out whether it gave the economy enough oomph to get back into orbit. 

Take a look at these two charts. First, the government contribution to GDP growth was negative in the first quarter–roughly one-third of a percentage point. This reflects mainly contraction of state and local governments–layoffs and reductions in investment. Basically any new building projects on the state and local level  have been put into the cold freeze.  

But the GDP stats don’t tell the full story, because transfer payments (Social Security, Medicare, unemployment insurance) are not included in the ‘government’ category of GDP. Instead, they show up in personal income.  So I calculated the government contribution to real personal disposable income growth.  That includes the change in government benefit payments and government wages and salaries, minus the change in income taxes and payroll taxes.

Surprisingly–at least to me–the government was a net drag on real disposable income growth in the first quarter of 2010.  A small drag to be sure–roughly 0.2% of disposable income–but certainly not a boost. An increase in benefits was more than offset by an increase in taxes paid.

In other words, the fiscal stimulus pretty much petered out in the first quarter.

So the second and third quarters will be key. Will the private sector be able to use the boost from the stimulus to get back into some reasonable economic orbit? Or will it fall back to earth again in a big splat?

Right now I’m evenly balanced between the optimistic and pessimistic possibilities in the short-run.  I see good signs of life, especially in the communications sector. But I worry about Europe, about cutbacks on state and local level, about trade and borrowing from overseas.  But that’s a different post.

Managers and Professionals: Public Sector Compensation Gains Have been Bigger

In the comments to my previous post, people raised a very valid question: Maybe the difference between the public and private sectors reflected the difference in the composition of the workforce. 

So I did the same exercise for managers and professionals in the public and private sector.  Here is the chart.

The lines are bouncier because I had to use data that was not seasonally adjusted. But the basic trends are the same–since early 2005, real compensation gains for public sector managers and professionals have outstripped the compensation gains for private sector managers and professionals.  The gap is somewhat smaller than in the previous post, but it’s still there.

Now, let’s agree what this chart does not say. It doesn’t say whether public sector workers are paid more or less than their private sector counterparts, especially  after adjusting for age and education (a thank you to Dean Baker who pointed this out to me).  It also doesn’t say whether private sector pay will rebound faster in the recovery.  But it does help suggest why states and cities are struggling financially.

Public Sector Pay Outpaces Private Pay

We all know that state and local government finances are a mess. This chart helps explain why. {IMPORTANT NOTE:  I REVISED THE CHART TO CORRECT A PROBLEM WITH THE INFLATION ADJUSTMENT}

The top line tracks the real compensation of all state and local government workers–wages and benefits, adjusted for inflation.  The lower line tracks the real compensation of all private sector workers.  The data comes from the Employment Cost Index data published by the BLS.

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.

This one fact explains much of the fiscal stress at the state and local level—why states such as New York, New Jersey, and California are in such a mess. State and local governments pay more than $1 trillion in compensation annually (actually, that’s an astounding number–I had no idea it was that high). If compensation is 5% higher than it should be, that’s $50 billion in excess pay costs for the state.

And lo and behold, that $50 billion would roughly cover the total size of the state budget gaps. For example,  in February a survey found that the combined budget gap of all 50 states was $55 billion for the 2011 budget year and $62 billion for the 2012 budget year . (The survey was done by the National Governors Association and the National Association of State Budget Officers)  

Now, I’m not anti-government, by any means. But this trend is disturbing. In times of crisis and economic struggle,  government workers should not be getting bigger pay increases than the private sector. The domestic private sector has really been struggling for a decade, both in terms of job and pay.  But the public sector kept paying higher compensation.

The arithmetic is very clear. State and local governments can’t keep funding higher wages and better benefits for their workers, while the private sector struggles. As a wise man once said, you can’t wring blood from a stone.  And you can’t ask troubled taxpayers to pony up bigger pay gains for government workers than they are getting themselves.

A Bad Decade: 10-Year Private Income Growth Goes Negative

Each month the BEA releases figures for personal income and disposable personal income. These figures are a mix of private sector income and money received by individuals from the government. These government payments take the form of wages paid to government employees, and social benefits such as Medicare and Medicaid.

So I decided to take a shot at calculating ‘private’ personal income. From personal income I removed government social benefits (about $2.1 trillion in 2009) and wages paid to government employees (about $1.2 trillion). Then I added back in contributions for government social insurance, such as Social Security and Medicare payroll taxes (just under $1 trillion). Finally, I adjusted for inflation and population size to get a figure for real ‘private’ personal income per capita.

Here’s a chart of  the 10-year growth rate of real private personal income per capita (the first quarter figure for 2010 is based on the average of January and February).  

Over the past decade, real private personal income per capita has fallen at a 0.2% annual pace, the first time that has happened since the Great Depression.

Let’s compare this with the usual figure quoted by economists, real disposable income per capita. Real disposable income per capita–which includes government wages and social benefits, and adjusts for tax changes–rose at a 1.2% rate over the past ten years. In other words, when we add in government spending increases and tax cuts, real incomes per capita rose rather than fell.

The logical conclusion is that the private sector has been crapped out for the past ten years. Even before the crisis hit, the main thing that  kept the economy afloat was the succession of Bush tax cuts and the expansion of federal spending which boosted benefits,  particularly in healthcare. 

This was a bad bad decade.


The Growing Gap between Govt and Private Sector Benefits

When I was out in Kansas City at the Kauffman Foundation’s Economic Bloggers Forum,  Mish Shedlock of  the blog Global Economic Trend Analysis made a persuasive case that state and local finances were completely broken because gov’t workers were overpaid compared to the private sector. ( See here for one of his posts on the subject).

Mish got me thinking…So I decided to assemble some BLS data on the subject.

Not to mince words, here’s the payoff chart,  that compares the benefits of state and local workers with private sector workers. (These figures are adjusted for inflation, and indexed to 2001I=100).

Yowza! Somewhere in 2004, the world changed, and we didn’t realize it.  Employers in the private sector put a lid on the cost of benefits (which includes healthcare, retirement, vacation, and supplemental pay of all sorts).  Meanwhile the cost of benefits in state and local govt jobs just kept rising, with barely any break, both before and after the financial bust.  This is not good

To put it another way, the benefits gap between the public and private sectors has widened sharply since 2004.


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