Until it becomes obvious that the eurozone trauma or some other crisis will sink the global economic ship, we will assume that the U.S. economic outlook is just one of slow economic growth. First quarter GDP was revised down to 3.0% from the previous estimate of 3.2%. After the recent disappointing nonfarm payroll and retail sales reports, consensus among economists for further growth has been reduced to 2.6%, still somewhat above our 2.0% estimate.
Because of the recent turmoil in Greece and fears that it will spread to other economies, several European countries have announced deficit reduction policies. Demonstrations in Greece, Spain and now Germany indicate that the anticipated withdrawal will not be as pleasant as the rush from years of exuberant spending. Fiscal restraint will be painful and prolonged. The crisis which started in Greece, and is only beginning to impact other countries, is coming to a state near you.
The rapid decline in state and local tax collections is being partially offset by federal government transfers. $246 billion in federal money will cover 30% to 40% of the state revenue shortfall this fiscal year. State and local bond debt increased $1.1 trillion between 2000 and 2009 to $2.3 trillion. These governments have used debt to fund investments that used to be accounted for on a current budget basis. Some have used debt to cover routine shortfalls. In addition to the increased debt load, states have significant unfunded pension and healthcare benefits for public employees. Some studies estimate that states and participating local governments have underfunded pension plans by $3.2 trillion. Because of federal help, states have been able to postpone teacher layoffs and other unpleasant choices. States estimate continuing deficits in the coming fiscal year which starts July 1st. However, taxpayers have neither the ability nor the will to sustain current levels of spending.
Half of state and local government spending goes to labor costs. There are measures that can be taken to reduce those costs in an orderly way. Two-tier wage structures are being established so that new hires are paid less than existing employees, but still at levels sufficiently attractive for qualified people. And the new hires are enrolled in defined contribution plans, and retirement ages are increased, too. Existing employees are having pay levels frozen. Some retirees are being asked to pay increasing shares of healthcare costs. These changes take time. Outsourcing some services to the private sector can reduce costs more quickly.
In the meantime, municipalities are starting to address the labor issue due to the precipitous declines in revenues. Antonio Villaraigosa, the Mayor of Los Angeles and a well-known friend of labor unions, in light of a daunting $484 million budget hole has called for layoffs of 3,500 city workers and 16 to 26 furlough days if unions resist pay cuts. In Tulsa, where the population grew 17% over the last 40 years and the police department budget went from $4 million to $87 million, 89 police officers were laid off.
States are taking measures, too. 59% of school budgets in New Jersey were rejected by voters. California is facing a significant restructuring of its university system, lying off 1,900 people in the past two years and cutting $232 million in operating costs. New York is threatening to close 41 parks and 14 historic sites.
Historically, the public sector was a source of stability for the economy. Initially, the social contract was that public sector employment meant lower wages than in the private sector, but there was job security and handsome benefits. But since the early 1980’s, there has been very little growth in real incomes in the private sector. Meanwhile, state and local government employees continued to receive pay raises in excess of inflation and now have wages 34% higher than their private sector counterparts. Attempts to restore a better balance will not be painless and may prove to be inadequate in the short run. But economic reality will force state and local governments to pursue restrictive policies for many years to come. These restrictive policies, currently making the news in Europe, will reduce growth in the United States, too.