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Connecting Compensation and Skill

IPR associate Max Schanzenbach examines the pay gap between public-private sectors


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Can differences in skill explain differences in pay between the public and private sectors?

When you go to work for the government versus a private sector company, you likely do so with the understanding that you will earn less working for your state or local government than say, Tim Cook at Apple. But is this true? And, if so, why? Recent research by law professor and IPR associate Max Schanzenbach reassesses this public-sector pay gap—the difference in earnings between public- and private-sector workers—to determine how differences in skill might account for those in pay.

According to existing research, high school graduates earn a “pay premium” in the public sector, earning 5 percent more on average than their private-sector counterparts. On the other hand, college graduates in the public sector earn 10 percent less on average than private-sector college graduates. However, the added benefits of working in the public sector, such as better health and retirement benefits, suggest that total compensation between the sectors is more equal.

schanzenbach
Max Schanzenbach

Focusing on college-educated workers, Schanzenbach shows that most of the existing pay gap can be explained by differences in worker skills between the sectors. Prior assessments have not considered skill differences, instead relying on rough proxies for skill such as years of education. Schanzenbach considers two well-known measures of skill in his analysis: scores on the Armed Forces Qualification Test (AFQT), an assessment used by the U.S. military, and undergraduate college major.

He finds that higher AFQT scores translate into higher pay for college-educated workers in the private sector, but not in the public sector. This suggests that the public sector fails to pay college-educated workers according to their skills, and not surprisingly, those with higher AFQT scores are much less likely to work in the public sector.

Schanzenbach also discovers that differences in college major explain as much as 60 percent of the public-sector pay gap, as workers with lower-compensated majors disproportionately select into the public sector and workers with higher-compensated majors are more likely to work in the private sector. This is not surprising, he surmises, considering that public-sector employees with higher-earning majors receive only a fraction of the pay earned by those in the private sector with the same majors.

“You have to start thinking about how much these people would make working in the private sector,” he explained. “And you have to think about how civil service rules and union contracts that encourage seniority pay and prevent significant performance pay would affect selection into the different sectors. Rather than saying public sector workers are over- or under-compensated, it may be more accurate to say they are ‘mis-compensated’ because state and local government do not pay for [their] skills.”

Though there are less tangible benefits of public-sector work, including job benefits and job security, Schanzenbach suggests that these alone do not keep high-skilled workers from flocking to the private sector. “We’re not incentivizing public-sector workers, we’re not compensating them for skill, and we’re not getting high-quality college-educated workers in the public sector,” he concluded.

Max Schanzenbach is the Siegle Family Professor of Law and an IPR associate. For more information, see the paper, “Explaining the Public-Sector Pay Gap: The Role of Skill and College Major."

Photo credit: Pictures of Money, Flickr.