Further cutting their salaries will only mean a weaker government.

The Bowles-Simpson chairman's mark strongly implies that government employees are overpaid (see here). But the evidence from any number of sources is that this is completely false, even when you include benefits and control for everything imaginable. Reihan Salam brought up an corollary argument, Andrew Bigg's argument that you have to include unfunded benefit liabilities in these comparisons. This was taken apart months ago by the National Institute on Retirement, so let's review that.

To get there, I'm going to first run through EPI's Debunking the Myth of the Overcompensated Public Employee (pdf), a pretty fantastic paper.  Lots of people have also done this research at the state level: Jeffrey Thompson and John Schmitt of CEPR for New England, California from the Center on Wage and Employment Dynamics at the University of California-Berkeley, etc.

We can break the entire argument about government employee compensation into three steps.

First step: education level

The first is an apples-to-apples comparison of workers among education levels. The government's workforce is more educated than the private workforce. For instance, the government's "college plus" level is 54%, while all private workforce is 35%, for instance. "Some college" is 14% of government workers, 19% of the private workforce. Here is the penalty government workers take when you include all benefits across both categories:

On average, government workers make 3% less total compensation when you control for education levels. As someone who once considered doing regulatory work with his professional Master's degree work, I completely agree that there's a 30%+ pay gap between the private and public sector. Tom Ferguson and Rob Johnson had a good paper at INET comparing the evolution of regulatory salaries and industry salaries -- the results were in line with the real incentive for regulators to be joining the industries they regulated.

Some groups make more in government.  This appears to be more the result of the declining wages and benefits over the past 30 years for non-college educated workers in this country than runaway government compensation. The paper notes: "The public sector appears to set a floor on compensation particularly improving the compensation of workers with high school educations, when compared to similarly educated workers in the private sector. This result is due in part because the earnings floor has collapsed in the private sector," citing Lee 1999. But on average, there's a compensation penalty for working for the government.

Second step: gender and race

On the first approximation, government workers are underpaid. So are we done? No. There are two more steps. Beyond education, there are other things we need to control for. State and government workers are "slightly less experienced (21 years compared to 23 years); are more likely to be female (57% to 43%); work fewer hours (42.6 to 43.3); are more likely to be black (14% to 12%); are less likely to be Asian (3% to 6%); and are less likely to be Hispanic (10% to 13%). [p. 9]"

We need to control for all of these factors, as they impact the comparison of wages. Government workers leave 6 minutes earlier each day, women make 80 cents on the dollar as the result of systemic gender discrimination men make $1.25 on the dollar because they are compensated for their evolution-derived risk-taking, aggression and promiscuity, older workers make more than younger workers, etc.

So the paper controls for all that (they put some time into this), and this is what they find:

Once again, controlling for everything imaginable, government workers make less in total compensation than regular workers.  The result is less pronounced at the local level (1.8% less rather than 7.5% at the state level), though still significant.

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Third step: cost of benefits

Now there is a third critique, led by Andrew Bigg of AEI, which says these two steps don't get the entire costs of providing benefits because "most state and local employees also become eligible for defined-benefit pensions and health benefits in retirement. But state and local governments haven’t come close to fully funding these obligations. That means that the amount government employers spend today may be well less than what employees will actually receive when they retire." He believes this is not the case for private employers, hence government workers are likely overpaid.

Let's hand the microphone to the National Institute on Retirement, which is specifically addressing Bigg's claims (my bold):

Some have argued that because many public pension plans around the country are not fully funded, the entire cost of defined benefit (DB) pension benefits is not recognized in the data we used in our study, which comes from the National Compensation Survey (NCS).  While the NCS, like any survey, does have some limitations, it remains the definitive source researchers use for assessing the cost to employers of non-wage benefits...

In other words, if an employer fails to fully pay for the benefits accrued in any given year, then it is possible that the cost of the pension benefit -- and therefore, the full cost of employee compensation -- may be slightly understated in the data.  The corollary to this is that if an employer’s contributions to a pension plan exceed the cost of benefits accrued in that year, the NCS will overstate the cost.  Because employer contributions can vary with the funded status of the plan, which in turn, is driven by macro-economic factors like the performance of stock and bond markets, there may be a cyclical bias in the data.  Over time, though, these over- or under-estimates should average out, which is why we used an average (from 2004 to 2008) of benefit costs, rather than a point estimate in our analysis.  Moreover, it is important to note that any bias (positive or negative) would apply equally to public or private sector employers.

So, claims that our analysis systematically understates costs for public employers are invalid on this basis.

Similarly, claims that our study should have added the value of the entire unfunded liability (of state and local government DB plans) onto a single year’s compensation costs are completely off base. Any analysis that does so will reach conclusions that are equally inappropriate and flawed.

First, an unfunded liability represents all accrued benefits, from all years past, that are not currently funded.  Yet the point of the analysis is to compare the cost of annual compensation.  Therefore, it is inappropriate to include the entire unfunded liability from all prior years into the calculation of the cost of benefits in a single year.

Second, even if one felt that incorporating the cost of unfunded liabilities served a purpose (notwithstanding that this is not how economists define current compensation), one would have to apply the same standard to the private sector side of the analysis, too. Currently, many private sector DB plans have unfunded liabilities -- a result of the recent stock market downturn that affected investors of all stripes. If the idea is to compare public and private pension costs in a fair, “apples to apples” manner, then the unfunded liabilities of private sector pensions should be calculated as well.

Third, adding the expected annual cost of paying off unfunded liabilities (even under the worst-case scenario) would not change the result.

The Center for Retirement Research at Boston College recently calculated that it will cost states on average just 2.2% of payrolls to pay off their entire unfunded liability over 30 years. In the Out of Balance report, we found that total compensation is 6.8% lower for state government employees and 7.4% lower for local government employees than for comparable private sector workers. So, even if we were to add 2.2% of payroll to state and local employee compensation -- which would pay off the entire unfunded liability -- state and local workers would still be paid 4.6% and 5.2% less, respectively, than their private sector counterparts.

In conclusion, the results of the Out of Balance study stand up to scrutiny. Even acknowledging the additional contributions that will be required to restore pensions to full funding does not alter the ultimate findings of the study. State and local employees still receive significantly less total compensation than their counterparts in the private sector.

Posted on July 19, 2010 by: Keith A. Bender, Associate Professor and John S. Heywood, Distinguished Professor; Department of Economics, University of Wisconsin-Milwaukee.

The idea that private market pensions are in tip-top shape doesn't strike me as accurate, and piling on the entire unfunded liability into a single year is, of course, going to distort the scales and not focus on the specific hypothesis testing that is being carried out. And yes, even if we were expecting to pay off the entire unfunded liability, we are talking about 2.2% of payroll, still less than what NIR, EPI and others found as the pay gap.

Again, there's simply little fat to cut here. Government workers are less compensated than private workers -- more cuts will simply mean a weaker workforce with less human capital, which will lead to weaker government services.  Which will discredit the idea of government, which I guess for some people is the point.

Mike Konczal is a Fellow at the Roosevelt Institute.

Regulatory capture is dangerous. But you won't find it in the agency's new hires.

Today's New York Times came out with a bizarre hit piece on the Consumer Financial Protection Bureau and the first wave of hires. They attempted to argue that there are already huge conflicts between those staffing the creation of the Bureau and those that they will be tasked to regulate. This will be a problem for any agency, and it's one to be very conscious of and make sure that proper disclosures and vetting have occurred.

But what's so surprising about the article is how little they were able to find. After going through the record of the initial hires of advisors for the CFPB, the only thing they were able to flag was that Warren advisor Raj Date was, up until recently, a director of Prosper Marketplace Inc. The company is lobbying to be regulated as a bank, instead of regulated by the SEC, debating whether their practices constitute issuing securities. I read the piece waiting for a bang, but all I found was a whimper.

Having written a paper with Date on Glass-Steagall and the future of financial reform, as well as working with Date when he contributed to Roosevelt's Make Markets Be Markets financial reform conference on the subject of the GSEs, I was kind of curious to see if he was actually some sort of deranged financial hitman. But if this is all the 'dirt', I'm almost worried for the opposite reason: that the agency will be too academic and not take advantage of people involved in the shadier side of the financial world who want to repent.

The Times article relies entirely on the implied assumption that peer-to-peer lending is some sort of shady, fly-by-night operation. In reality, it is simply part of the over-hyped phenomena of trying to integrate the internet with new financial institutions. From Mark Gimein's very critical take on the company:

Person-to-person lending -- loans made by individual investors who had money to spare to borrowers hoping for better rates than they could get from banks or credit card companies -- was supposed to be to loans what eBay was to garage sales. Prosper.com, the pioneer, was one of most hyped internet startups of the last decade.

TIME Magazine chose Prosper.com as its top new website of 2007, and the Wall Street Journal featured it in a high profile story. Prosper television commercials picked out nifty stories like that of a New York cop who lent money to a Chicago fashion designer, and the press followed with quirky human interest stories (like a loan for breast implants). In short order, Prosper was followed by imitators such as Loanio and Lending Club -- the latter a Harvard Business Review featured in the Harvard Business Review's picks for “breakthrough ideas for 2009.”

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"Most hyped internet startups of the last decade." You don't get that impression from the Times article. It merely quotes a default rate to condemn the practice. And Prosper contested that measure of default rates when Gimein wrote about them for Slate, both as a solid measure of its business and particularly in the context of a gigantic credit bubble and the Great Recession (where everyone is having to take massive consumer credit writedowns).

In my personal opinion, in the same way middle-class people turned amateur stock analysts was the sign of a tech bubble, or middle-class people turned amateur realtors was the sign of a housing bubble, middle-class people turned amateur credit risk analysts and credit channel intermediaries was the surest sign of a credit bubble. But Prosper has been a useful experiment. It's challenged thinking about information, prices, the "wisdom of crowds" versus institutional information, fringe lending, and creative ways around low-quality high-churn payday-style lending, regardless of whether or not it is going to take off. Either way, wasn't the problem that the CFPB was going to kill small-scale financial entrepreneurialism? So isn't it good to include someone in the agency who has experience with it?

Even more striking is that the article fails to mention that Date and his former policy shop, Cambridge Winter, which they summarize as being "active in the Dodd-Frank debate", were really at the cutting edge of the consumer financial protection debate. I actually wasn't sure if the auto dealer exemption for consumer protection was something worth fighting until I read Date's Baseline Scenario post on the topic, Auto Race to the Bottom. Particularly pertinent was the excellent phrase: "Even by the low analytical standards applied to hastily arranged, crisis-driven corporate welfare initiatives, the exemption of auto dealers from the CFPA appears profoundly ill conceived. Exempting auto dealers would simultaneously be bad for consumers, bad for industry stability, and bad for what remaining sense of free-market integrity we still have." Heh.

He was also active in the Volcker Rule debate, bringing sanity to the discussion of the strengths and weaknesses of resolution authority (also here), and a whole ton of other research that created markers for serious financial reform.

The case against him is so weak that even Mark Calabria, director of financial regulation studies at the Cato Institute, who loves hitting a regulatory conflict and capture slowball over the plate, seems kind of bored with it when he's quoted: “It would be very difficult to find anybody on either side of the aisle on this issue who doesn’t have a financial interest. What’s important is that those conflicts get aired.”

The issue of regulatory capture is a serious one, and I'll worry when President Palin is appointing credit card company executives to run the CFPB. But if this is the 'worst' that can be found out the door, the capture part of it is the least of my concerns.

Mike Konczal is a Fellow at the Roosevelt Institute.