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Problems and Costs Unique to Public Sector Unions

I was doing an interview for a radio station in Philadelphia this month when the conversation turned to the protests over "anti-union" proposals made by Wisconsin's governor Scott Walker. I was asked if I found it strange that various private sector unions were demonstrating in sympathy with the public sector unions. No, I don't find the pervasive sense of union "brotherhood" between private and public sector unions strange. They are constantly under attack and there may very well be strength in numbers. Another reason I don't find it strange is that most people have not thought that much about the difference between the two. That includes the media covering events at Wisconsin's capitol.

The Difference

There are actually a few key differences between public and private sector unions. First, a private sector union will negotiate with ownership/management over the distribution of profit. All such negotiations are done to determine who gets what share of the profit. Once that profit is fully allocated, there can be no further gains to either party. Every penny of profit is spoken for. In other words, private sector union demands are limited to 100% of the profit. There is no such check on public sector unions because there is no profit. Union wages and benefits in the public sector are not paid out of profit at the expense of the capitalists. They are paid for through taxation. The only constraint that exists at the public sector union bargaining table is the creativity of the union, or the courage of politicians to say "no." There is no finite monetary ceiling to public sector union demands, so there is no check on their power.

Second, when a private sector union tries to negotiate a new collective bargaining agreement, they do so with management/ownership directly. Every concession given to labor comes out of the pocket of ownership and every penny given to ownership comes directly from the pockets of labor. When these two parties negotiate, they sit on opposite side of one table in one room. Public sector unions do not negotiate directly with those who pay their compensation packages - the taxpayer. They negotiate with elected politicians. Politicians give up nothing out of pocket when concessions to public sector unions are made. The public may use threat of electoral ouster against the politician, but then again, perhaps that politician's constituency is comprised mainly of union members. This changes the bargaining dynamic in public sector union negotiations.

There is one final, but crucial, difference in the two types of unions - the threat of strike. When a private sector union strikes, there are usually some alternatives for the public to get the same or similar goods and services from non-striking companies. If meat packers are on strike, you can eat chicken. If GM auto workers strike, you can buy a Toyota. The same alternatives are not available in the public sector. When the city's garbage collectors go on strike, there is not a competing garbage collector that the public can use. The garbage goes uncollected until a resolution is reached between labor and government. This is a tremendous advantage of public sector unions, amounting to considerably more bargaining leverage than the private sector counterparts. Because alternative solutions for goods and services do not exist, it usually will not take long before the public becomes anxious and ultimately looks to the politicians to resolve the conflict. Politicians need to get re-elected, so once their constituents start chirping about how much pain the strike is causing them, politicians realize the union has all the leverage and labor demands are generally agreed to. This leverage comes from the fact that public sector unions exist only in monopolized industries. Competition would act as a natural check on the power of these unions, but no such competition exists.

Whether you like unions or not is really irrelevant from an economic perspective. Both sides of the issue must agree that the unionization of an industry has a cost. That's self-evident. But we should be clear as to who pays the cost - consumers pay the cost of private sector unions and taxpayers bear the cost of public sector unions. In the case of private sector unions, the cost of union labor above would be expected in a competitive and free labor market is passed on to the consumer in the form of higher prices for union-produced goods and services. In contrast, the cost of public sector unions is born entirely by the taxpayer through higher taxes, future debt burdens, inflation, or a reduction of services in other government-subsidized areas. The point is that there is always a cost. The only variable is who pays it.

The Cost of Public Sector Unions

Recent budget debates at the state level have begged the question, "Exactly what is the value of public sector unions?" Value is not just about cost and it's not just about benefit. Value is benefit relative to cost and it's subjective. Some may argue that the benefits of public sector unions are well worth the cost. Others may think public sector unions offer very little benefit and significant cost. Still others may be indifferent.

Whatever the case, before we determine the value of public sector unions - and that is exactly what the current state budget battles are grappling with - we must know what the benefits and costs are. It would be even better if both were easily quantifiable. Unfortunately, that is not the case. Scholarly journals are surprisingly mute on the subject of benefits of public sector unions. To be sure, individuals, who belong to public sector unions benefit. But very little is available that examines the benefit to society as a whole. Even unions themselves have a difficult time articulating the societal gain. We will leave it to others to develop a theory of how society benefits as a whole from public sector unions. Chances are, even if such societal benefits exist, they will not lend themselves easily to quantification.

On the other hand, cost is much easier to quantify, albeit through imperfect means. First, the US Bureau of Economic Analysis tracks compensation in the private and public sectors. Since we are undergoing the following analysis specifically to address state budget concerns, we will restrict our use of the phrase "public sector" to state and local governments only. Federal government employees will not be considered.

Having said that, our first step will be to determine the scope of union membership in the public sector. If the percentage of employees in the public sector belonging to unions is small, the entire exercise would be unnecessary as the costs would be relatively small. But, as the chart below shows, while not all state and local government employees are members of a union, a significant portion are. Union membership in the public sector is not a trivial matter.

State and local government union membership constitutes over 40% of all employees in the sector. Conversely, unions account for less than 7% of the private sector workforce. Since the late 1970's, private sector unionization has dropped from 20% to the current low level of less than 7%, while public sector unionization has remained stable at 40%. The difference in union membership in the two sectors has led to a widening gap in compensation.

More telling than these figures is the data compiled by the Bureau of Labor statistics. They publish a breakdown in per-hour compensation between the private and public sector in three key areas: "management and professional," "sales and office," and "service." A direct comparison can then be made between two people from two different sectors - public and private - doing essentially the same work, which requires essentially the same skill set.

Note that state and local government employees are compensated, on average, 49.5% more than comparable employees in the private sector. Average per-hour compensation for public sector employees is $17.86 more per hour than the private sector. The biggest percentage gap between the two sectors is benefits. Specifically, the public sector is compensated considerably more in the areas of Defined Benefit retirement plans, Health Insurance and Paid Leave. These are probably the most highly-valued benefits of any employee and account for roughly one-third of the $17.86 per hour compensation difference between private and public sector laborers.

In addition, consider that private sector employees work more hours per year. They average 2,047 hours annually versus 1,824 annual hours for public sector employees. The disparity in key benefits and hours worked is evidence of the bargaining power that public sector unions have over their weaker private sector brethren.

Clearly, the premium paid to public sector employees over their private sector counterparts is unnecessary to induce people to do this type of work. But what does this "overpayment" really cost taxpayers?

The Cato Institute recently tried to figure this out by running a linear regression on the data presented above to isolate how much of the wage differential is due solely to the presence of public sector unions. Given current unionization rates and compensation statistics, Cato estimates that public sector unionization costs taxpayers about $89 billion per year. It is important to note that this simply reflects the impact of current compensation. It does not account for the estimated $3.56 trillion in unfunded public sector pension liabilities that will start to come due in the near future.

That $89 billion equates to $1.78 billion per state, per year. When you consider that the entire firestorm in Wisconsin is the result of the governor's trying to eliminate a two-year budget deficit of $3.6 billion, this is not pocket change. It is literally the difference between balanced budgets and budget deficits.