Wednesday, July 18, 2012

Problems to Economic Recovery: State and Local Governments

In my post yesterday, I wrote about the slow economic recovery taking place and the need for the economy to achieve some structural reforms for economic growth to return to a level more consistent with that achieved over the past fifty years or so: a 3.2 percent year-over-year rate of growth.

I argued that one of the economic sectors in need of a major restructuring was the state and local government sector.  Well, this post has been followed by several reports in major newspapers concerning the problems that specifically plague the states.  For example, the New York Times had a front page article on Wednesday morning while the Financial Times contained a similar report. 

The Financial Times summed up the news: “US state governments are in desperate need of reform to solve structural challenges that extend well beyond the cyclical woes of the financial crisis and the recession, including $4 trillion in unfunded pension and healthcare liabilities.”

The difficulties of state governments have grown as the economy slowed and failed to strongly rebound although some states have recently experienced rising revenues.  However, people are being cautioned about becoming too optimistic that the worst is over.

In addition, local governments, as we know given the recent municipal bankruptcies, are also facing continued dark times.  Local governments depend upon property taxes for about 74 percent of their revenue.  These governments have been starving over the past couple of years as the “middle class piggybank”…home prices…have fallen.  And, although there appears to be some leveling out of housing prices, any major recovery of property prices seems somewhere out in the future. 

Furthermore, given the fiscal problems in Washington, D. C., there has been talk of removing the tax exemption of municipal bonds.  This possibility of this occurring could certainly cause uncertainty to rise about what yields investors might receive on their investments in “munis”. 

States and local governments, although most of them have some kind of “balanced budget” constraint placed upon them, have run deficits for years and years.  Residents of these areas have constantly demanded more and more services, education, health, prisons, courts, and other agencies as the middle class has grown and as the middle class “piggy bank”…home prices…have been able to underwrite the increases. 

Furthermore, there has been another factor at work as well, swelling state and local government budgets.  Public unions have grown from a relatively insignificant part of the labor movement to the point where, at present, more than 50 percent of all unionized workers are employed by the government.  State and local governments have been able to pad their payrolls, increase salaries and wages, raise health and pension benefits, and create better and better working conditions during the past fifty years as credit inflation and housing price bubbles have inflated the revenues of these governments.

Still, the revenue increases have not kept up with all of these expenses.  As a consequence, state and local governments went to the well…they found out how to use “create accounting” techniques.  This is why these state governments find themselves with $3 trillion of unfunded pension plans and $1 trillion of unfunded health care plans.

And these states must take care of building the new infrastructure of America, of providing a new health care program for America, and of dealing with cries for better schools, a better social net, and a fully staffed organization.   

In addition, this whole state and local government mess is going to get caught up in the next “big” fight about the existence of labor unions!

The health of the labor unions is tenuous.  “The number of workers who belong to a union has plummeted about 20 percent over the last decade.  Only 8 percent of all workers are unionized.”  This from a recent New York Times article, which discusses the future of unions. 

Unions in the private sector have declined dramatically over the past forty years, and, the only real source of strength in the union movement has been in the public sector.  But, now with the sour economy and with a depressed housing market, government budgets are being stretched to the limit and the “creative accounting” is coming back to haunt the state and local governments.  The resolution of these difficulties is not going to take place in the near term and this will lead to more and more fights between governments and public labor unions.

Evidence of this was seen in the tussle that recently went on in Wisconsin between pro-union supporters and Wisconsin Governor Scott Walker. Furthermore, as the New York Times article states “nonunion workers tend to resent rather than applaud the better pay and benefits of their unionized brethren,” adding to the pressure against unions trying to achieve their goals.

But, there will be a fight in the public sector because public sector unions grew up on little resistance from public sector officials.  This was because the public sector officials could always tap into, without much complaint, the rising value of property values and pass-off these rising costs.  If not that, then there was always the deep pockets found in Washington, D. C.  Now, however, the “free lunch” is over.

So, expect a lot of turmoil in state and local governments over the next five years or so.  Budget realities are setting in at all levels. Pensions cannot go unfunded indefinitely.  Health care costs cannot go unfunded indefinitely.  And, public sector jobs need to be filed in order to cover ordinary, day-by-day operation.

Moreover, the federal government is looking for ways to tap into more revenues, like taxes on municipal bonds, or more cuts in expenses, like less funding of state prisons along with their call for more state and local participation in health care and law enforcement.   
There are massive structural problems that must be dealt with in the United States.  Correcting these structural problems is a part of what must be done to help get the US economy growing at a more rapid pace. At the end of this time, it is likely that labor unions in general, and more, specifically, public labor unions, will be an even weaker part of the United States economic scene than they are now. 

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