Wage Compression Limits Quality of Public Sector Workers

The substantial widening of wage inequality in the private sector and the relatively more stable wage distribution in the public implied that high-skill workers became increasingly more likely to end up in the private sector.

The financial rewards offered by the public sector may be inadequate to attract and retain highly skilled and highly motivated workers, according to a recent study by NBER Research Associate George Borjas. This is not because the level of average wages lags the private sector, a common benchmark used for measuring the economic incentive to take public and private sector jobs. In The Wage Structure and the Sorting of Workers into the Public Sector (NBER Working Paper No. 9313), Borjas focuses on wage dispersion within the public and private sectors and shows that the relative compression of public sector wage schedules over the past 20 years is an important determinant of its ability to attract high-skill workers.

While the wage structure has been stable in the public sector, higher wage inequality in the private sector has increased the potential rewards for high-skill workers. The fact that wages for the different skill groups changed at very different rates in the public and private sectors during the 1980s and 1990s implies that the economic incentives that induce people to enter or leave a sector also changed over the period. Using data from the U.S. Census and the Current Population Survey, Borjas shows that the relative skills of the "marginal" people who moved across sectors responded to the changes in relative wage dispersion. In particular, it became increasingly difficult to attract and retain high-skill workers in public sector jobs.

In 1960, the public sector employed about 16 percent of the U.S. workforce. This rose to a peak of 20 percent in the 1970s, and by 2000 had fallen back to 16 percent. Much of this decline can be explained by falling employment in the local government sector.

Women are more likely to be employed in the private sector than men, but the trends are the same. The share of workers in the public sector peaked at 17 percent for men and 22 percent for women in the mid-1970s. By 2000, 14 percent of men and 19 percent of women were public sector employees. In general the gap between private and public sector wages for a typical male employee was stable over the period, while it declined substantially for women.

Borjas shows that the wage distribution in the public sector has been relatively stable over the past 20 years, while wage dispersion in the private sector has increased. Looking at the ratio of the standard deviation of log weekly wages between the public and private sector, he shows that this ratio was 0.9 in 1971 and declined to .75 by the late 1990s. The debate about the causes of the rise in private sector wage dispersion centers around the role of skill-biased technical change, the increased globalization of the economy, immigration, and declining union membership

Borjas shows that the wage differential between people who had just quit the public sector and workers who were about to enter that sector is strongly and negatively correlated with the relative dispersion of incomes in the public sector. As the wage structure in the public sector became relatively more compressed, the public sector found it harder to hire and to hang onto high-skill workers. Studies of wages in the public and private sectors tend to focus on the earnings gap of the average worker between the two sectors. But, the substantial widening of wage inequality in the private sector and the relatively more stable wage distribution in the public implied that high-skill workers became increasingly more likely to end up in the private sector.

Studies that focus solely on the earnings gap between the typical worker in the public sector and its statistical counterpart in the private sector, Borjas concludes, provide only a partial picture. Relative wage dispersion - the shape of the wage structure - is an important factor in determining the public sector's ability to attract and retain high-skill workers. This analysis suggests that future policy discussions of public sector wages should pay more attention to the relative dispersion of income opportunities offered to government workers.

-- Andrew Balls