The Public-Private Pay Differential Post author By Philip Lane Post date November 9, 2009 Last week’s SSISI meeting featured a paper by Patrick Foley and Fiona O’Callaghan of the CSO and a ‘vote of thanks‘ by Seamus McGuinness of the ESRI. Categories In Economic Performance, Fiscal Policy Tags public sector pay in Ireland 20 Comments on The Public-Private Pay Differential ← Martin Wolf on the Irish Economy → The Visual Display of Data 20 replies on “The Public-Private Pay Differential” that was a really interesting meeting, one troll (not me for a change!), but otherwise a great and informative time, i’m surprised that the place wasn’t packed. I’m interested in Seamus McGuiness’s analysis of the use of an organisational size control variable. He concludes that it is wrong to use this variable when using the NES data since: “within the NES there is only one return for the primary and secondary education sectors, for each division of the civil service, and one return for the army, guards and prison officers (Table 3). Thus the NES data are not in fact capturing the size of primary schools, secondary schools and garda stations; instead they appear to be capturing the total number of primary school teachers, secondary school teachers and gardai employed within the public sector. These aggregates do not relate to any organisational size measure, as it is commonly understood, and, therefore, it is likely that wage models estimated with this variable will contain substantial measurement error given that the large organisational size premium will undoubtedly be applied to many public sector workers located in small schools, garda stations and civil service offices.” The assumption seems to be that any premium associated with large organisations is “derived primarily from private sector productivity related economies of scale” (this quote is a reference by McGuiness to Kelly et al’s paper of this year). If, however, one were to suppose that the large-organisation premium arose from differences in the human resources management systems of small and large businessese then the local garda station, primary school etc. isn’t necessarily the appropriate unit and there might be more validity to this variable. @James Just to try and translate: Currently the comparison is made between aggregates of public servants and their private sector equivalents at large corporations (with pay and conditions at small businesses excluded). As many public servants work in small units, Mr. McGuiness argues they should be compared with equivalent size business units. Have I got that right? You respond by saying that the state is in effect a large corporation (using the size of the HR ‘department’ as a metric). But that still doesn’t get around the fact that in the private sector, different employees in different sized organisation get paid different amounts under different conditions for what is essentially the same job. I remember talking to someone who worked in sales for Freemantle (the media company). They had the worldwide rights for Baywatch and he was the salesman. He said it was the most boring job in the world, because you walked in and everyone wanted it and agreed to the price. On the other hand, a salesman for a start-up TV program in a small distribution company has an incredibly hard job getting anyone to buy from him. The likely pay and conditions are vastly different, even though they are both TV show salesmen. That there is no distinction in pay and conditions between a garda in a quiet rural station and one in Crumlin does not mean that there shouldn’t be. Otherwise, can I please be paid the same as someone who works at a big company? Essentially, the data collectors are treating gardai and teachers as working in branches of a big organization. Does anyone know to what extent private companies with similar branch networks – e.g. Tesco/Dunnes (maybe someone else can think of others that aren’t franchises) – pay workers in different branches differently? And if they do, do the differences depend on local labour market conditions or on the size of the branch? James is right that it really matters why big firms pay more if we are to judge whether including the firm size variable is valid or not. I tend to think of it as a personnel economics issue – monitoring being more difficult in larger companies, so efficiency wage arguments arise – in which case, inclusion of firm size is probably valid. I’m open to correction, though. I think the point made by Mr McGuinness relates to the application of both common sense and fairneess. In the NES data almost 95 of public sector workers are identified as belonging to large organisations (as opposed to less than 40 per cent in the 2001 ECHP). Given this the OLS framework will result in virtually all public sector workers recieving the large firm premium (of around 10 percent that is generated by predominately by private sector MNE’s). To suggest that this is a legitimate thing to do is ridiculous in my view. Also with my understanding of the literature the organisation size variable usually included in such studies relates usually relates to the size of the local unit (such as collected by the ECH)P. Does anyone know of any other study in the literature that specifies a model using an NES type measure of organisation size? Surely the main issue here is that private sector and public sector organizations become large for totally different reasons. Large private sector concerns all started off as small businesses, and usually became large due to their success in the marketplace (modulo construction bubbles and bank guarantees). The wage premium in these firms reflect this success. Large public sector organizations on the other hand owe their size to their monopolistic position and bureaucratic resource-grabs. So there’s no justification for a wage premium in that case. @Yoganmahew “Currently the comparison is made between aggregates of public servants and their private sector equivalents at large corporations (with pay and conditions at small businesses excluded). As many public servants work in small units, Mr. McGuiness argues they should be compared with equivalent size business units. Have I got that right?” Yes, except that only some studies “currently” do the comparison in the way Seamus McGuniness objects to. “That there is no distinction in pay and conditions between a garda in a quiet rural station and one in Crumlin does not mean that there shouldn’t be.” That’s quite true. But it’s not really the issue in my view. The point is that there isn’t really any local autonomy in wage-setting in individual schools and garda branches. Even if there was great diversity of wages between a garda in Crumlin vs one in a sleepy hamlet (do we have hamlets in Ireland?), the point is that the decisions are being made centrally, hence (the argument goes) wages should be compared with large scale private sector employers, not SMEs. Of course what so often gets lost in this debate is the point of the comparison – which is very often seen differently by different participants in the debate. What question do we want the comparison to help us answer? Is it something like: “are public sector wages fair, given their private sector equivalents?” Or is it “what would wages look like in a public sector being run along similar lines to the private sector?” Or “what is the lowest wage level compatible with an effective public service?” Or something else? If working in a large organisation or joining a trade-union are a consequence of public sector employment then surely they should be excluded from any model attempting to measure the impact of public sector employment on wages. Also, at 95 per cent coverage, it looks as if the size control is almost perfectly colinear with the public sector variable. I would agree with martin that this does not seem to be standard – certainly the Boyle Elliot & O’Leary (2004) paper relates to the size of the local unit. By the logic applied in the CSO approach should we not also be grouping all construction workers covered by industry level agreements as belonging to a single organisation? Or indeed all private sector workers whos wages are determined by the national wage agreement? @ Prop Joe, Getting big due to market success and getting big due to a monopoly position are not necessarily always different things. Where there are economies of scale (or barriers to entry), simply being there first can guarantee a company monopoly rents. And if you think economies of scale justify a wage premium in the private sector then why not in the public sector? @James Thanks. The point of lack of local wage-setting is well made. Is it, would you say, the result of a desire for fairness or a ‘restrictive’ practice? @Aedin Perhaps a better comparison would be with the different units in a multi-national (i.e. the different units within Ireland). I can’t understand why this issue of utilising such an entirely arbitrary variable as a control pops up so often. Size is a current characteristic of an organisation, but doesn’t say anything of the processes or history that led to the characteristic taking it’s current shape. Correlation, where it exists, does not alone imply causation – sizes may converge for entirely different reasons. This video (Monty Python’s Witch Scene) takes a humorous look at the convulted and corrupted logic that may result from reasoning, via induction, based on arbitrary features of a set of artifacts. (http://www.youtube.com/watch?v=yp_l5ntikaU) Do these studies control for other (less arbitrary) variables, such as location? Surely average private sector salaries in say Lifford, Co. Donegal are much lower than in Dublin. Yet, public servants working there get paid the same as those in Dublin. It makes sense that larger revenue generating companies with better economies of scale (and proven market success) can pay more. How many of our public sector organisations are revenue generating? Surely they are better viewed as cost centres, and managed accordingly.. @ Mack I disagree that size is an arbitrary variable. It is an empirical fact that bigger private sector companies pay higher wages. That does not necessarily mean, however, that public sector organizations should pay higher wages – it matters why private sector companies pay those higher wages. If it’s the case that big private sector companies pay higher wages because they have monopoly power and workers successfully capture some of that rent, then we would not want public sector wages to reflect the private sector size premium. If big private sector companies pay higher wages because big companies tend to arise in sectors where there are economies of scale, then again, we would not want public sector wages to reflect that premium unless we can be convinced that there are economies of scale in the public sector – this may vary across the public sector. But if big private sector companies pay higher wages because large organizations find that paying above market-clearing wages maximizes their profits – it reduces monitoring costs because workers are more motivated, it improves the average quality of applicants or whatever other efficiency wage argument you find most convincing – then not to allow public sector wage setters to behave in this way is sub-optimal. In this case, including organization size is valid. @ James Conran The question the ESRI researchers seem to have in mind is ‘what would a public sector worker earn if he switched to the same job in the private sector’ – which is why they object to the firm size variable, since in most cases the public sector worker would have to switch to a smaller firm. But in general discussion, it seems to me that what people have in mind is your second version – “what would wages look like in a public sector being run along similar lines to the private sector?”. In that case, including firm size looks at least like it has the potential to be reasonable. @Aedín – I disagree that size is an arbitrary variable. You spend most of the rest of your comment asking questions that demonstrate that it is. Part of the problem here seems to be we’re entering a morass of comparing public and private sector wages were it may not make sense to do so. E.g. From your question on monitoring costs etc, it may make sense to pay higher wages in some instances in the public sector, but that should be justified internally on cost savings not by way of external comparison to the private sector. So, either we benchmark wages in the public sector to those in the private sector (without such arbitrary distinctions as organisational size) or we look at how best to manage the public sector internally (either way, I think we’ll get the same result today). What we shouldn’t do, is allow vested interests to manipulate the process so as to choose whichever options benefit them. @ Mack to me ‘arbitrary’ means ‘pulled out of thin air’. I was trying to point out (obviously not very effectively) that it’s not pulled out of thin air – it is at the very least debatable whether it should be included or not. Most labour economists take efficiency wage explanations of wage determination very seriously – which is why I mentioned in my earlier post that it was the explanation of the size premium that I lean towards. In that case, including it is valid. Hi Aedín, Ok, I agree it’s not just pulled out of thin air – I only took issue with what you wrote (specifically) because you asked more illuminating questions rather than providing a definitive answer. Is there hard evidence that large companies pay higher wages based on wage efficiency and not because of any of the other reasons listed? Is there hard evidence that smaller companies do not employ the same strategy? If not – then surely the choice of organisation size as a control variable over hiring strategy employed is largely arbitrary (and possibly a mistake)? Btw, would the returns on wage efficiency in the public sector have to be compared with jobs/companies in the private sector where they match to make it a valid comparison? Would these vary across industry, job role, etc? @Aedín, Doesn’t the security of tenure usually associated with public sector employment militate against your efficiency wage argument? @ Frank against the classic Shapiro-Stiglitz work-shirk model, yes certainly. But not, I think, against the gift-exchange kind of story that tends to be supported by behavioural studies, or the adverse selection version. @Aedín then not to allow public sector wage setters to behave in this way is sub-optimal. In this case, including organization size is valid. Is there a degree of circulatory in this? Are we saying that it is better for large companies to pay above market-rate wages (presumably because they can – why?), so therefore public sector wages should be higher too? @Aedin “It is an empirical fact that bigger private sector companies pay higher wages.” and “Does anyone know to what extent private companies with similar branch networks – e.g. Tesco/Dunnes (maybe someone else can think of others that aren’t franchises) – pay workers in different branches differently?” do not seem to sit well together. In retail terms, no-one would accuse Tesco or even Dunnes of paying their employees ‘higher’. While Ryanair on average pays its employees higher wages, specific classes of Aer Lingus employees benefit more. IBM have traditionally had a wage strategy that goes something like “work for us and learn cutting-edge stuff, or work for someone else and get paid more” (not sure it is the case anymore, but that’s how it used to be). All the big companies I’ve worked for live by the Dilbert adage “We recruit the best, that’s why we pay market-average wages”. @ YM Anglo wages were by all accounts higher than BOI or AIB in a lot of situations. Hedge funds pay a lot more than mainstream banks typcially. WalMart employees would also probably disagree with the alleged “bigger is better” idea. Comments are closed.