Real Story in U.S. Compensation Growth: Workers in State and Local Government Fare Better Than Those in Private Sector

Global Insight projects that growth in state and local government workers' wages will peak in the third quarter of 2008, with a year-over-year gain of 3.1%. Moreover, persistently high benefit costs could drive yearly compensation growth for that quarter close to 5%. In private industry, we expect compensation growth will peak at 3.5% in 2007, driven by wage acceleration and benefit cost gains. Over the long run, compensation growth should moderate to around 3% per year.

Typically, the third quarter shows the strongest gains for the calendar year in state and local worker compensation. Most local governments run on a staggered fiscal year, meaning that bonuses and annual payments (which typically cause the first quarter of the year to be strong for the private sector) yield robust compensation gains in September. In addition, new contracts for teachers and other education service workers kick in at the start of the school year, meaning gains in compensation are reflected in the third quarter of each calendar year. Even accounting for this seasonal pattern, state and local compensation growth was unusually strong in the third quarter of 2006, up to 4.1% year-over-year (y/y); private industry compensation gains were just 3.1% y/y. Since 2001, compensation gains for both private industry and state and local workers have picked up considerably, but state and local workers edged out private industry workers, 19.6% versus 17.6%.

In both cases, rising benefit costs have driven the compensation gains. Group health insurance premium increases were commonly at the root of benefit cost increases. The Bureau of Labor Statistics reports that group health insurance costs grew nearly 9% annually, on average, from 2001 to 2005. Many private industry establishments responded by raising doctor visit and prescription co-pays and passing higher costs through to employees. As a result, the growth in benefit costs for private industry has been decelerating, from a peak annual rate of 7.3% in the second quarter of 2004 to 2.9% in the third quarter of 2006. Benefit cost increases for state and local governments, though, have stayed persistently high, peaking at 6.8% for the year ended in June 2003 and retreating to only 5.2% for the year ended in September 2006.

State and local workers have not faced the same hikes in their out-of-pocket expenses as their private industry counterparts. Therefore, benefit costs for state and local governments remain elevated. As wage pressures mount and wage gains begin to pick up slightly, state and local governments face mounting compensation concerns. Global Insight expects easing benefit cost pressures to allow for wage growth in the private sector. As benefit costs remain elevated for state and local governments, however, wage gains will either remain depressed or compensation growth will accelerate only moderately for workers.