Local Government

Cost Disease

Peter O’Reilly

Background for talk

• Relevance to our work

• Budgeting

• Why simply cannot slash

spending

• Discrete benefits of cost

disease

• more $ available to spend

• labor outlook/wage demand

Patience

• Counterintuitive

• Research driven

• Economic focus

• Focus on how things are

(versus how things should be)

• Long-run consensus & acceptance

William Baumol

• U.S. Army Veteran - WWII

• Economics Professor

• New York University

• Princeton University

• Authored more than

• 80 books &

• Hundreds journal articles

• Global Award for

Entrepreneurship Research

Recipient

• Noble Prize candidate

Baumol’s Cost Disease

America’s Health–Care Expenditure

1960: 5% of GDP

2012: 18% of GDP

Baumol’s 2012 prediction:

2105: 60% of GDP Current cost growth 1.4%/year GDP

versus

Historical inflation rate: 3.4%/year

(1914 – 2020)

Municipal Government

Macroeconomics of Unbalanced Growth: The Anatomy of

Urban Crisis by William J. Baumol, The American

Economic Review, Vol. 57, No. 3 (1967), p. 423

“The bulk of municipal services is, in fact, of

this general stamp [non-progressive] and our

model tells us what can be expected as a

result… inexorably and cumulatively, whether or

not there is inflation, administrative

mismanagement or malfeasance, municipal budgets

will almost certainly continue to mount in the

future, just as they have been doing in the

past. This is a trend for which no man and no

group should be blamed, for there is nothing

that can be done to stop it.”

Baumol’s Cost Disease

Powerful tool for understanding

modern economic world

Influence generations of

Economists and Policy Makers

Productivity

Productivity

Productivity measures output per

unit of input

Productivity

Classical economics dictates

wage growth is the outcome of

increased productivity

Baumol meets Beethoven

Same number of musicians is

needed to play a Beethoven

string quartet

• today vs 19th century

• productivity of classical

music performance has not

increased

• Musicians’ real wages have

increased greatly since the

19th century

Hypothetical Productivity Lag example

2010 2020 % Change

Widget industry

a. Widget output per worker per year 200,000 300,000 +50%

b. Annual wage $20,000 $24,000 +20%

Unit labor cost per widget (a/b) $10.00 $12.50 +25%

Tax Collection

c. Line Items 3,000 3,000 0%

d. Annual Wage $58,500 $70,000 +20%

Unit labor cost per line item (d/c) $19.50 $23.33 +20%

Stagnant Productivity

• Some industries outpace others

• Employers in stagnant industries must

• Increase wages • more than inflation

• prevent defection

• Prices rise

Cost Disease prevails

Cost Disease

• Most Virulent for…

• Industries difficult to

• Automate

• Standardize

• Require much human interaction

• Healthcare

• Education

• Local Government

Innovation & Privatization

A cure for Cost Disease?

Innovation

Hours to assemble a car:

• 1979: 41

• 2003: 24

• 2013: 2

Innovation

Municipal/County CFO

Ledger Paper

-> Computer Spreadsheet

Paper Based Banking -> Online Banking

Financial Accounting Software & State

reporting integration & automation

Moynihan’s Corollary

“Activities with cost disease

migrate to the public sector.”

Policing

• Colonial America -> a for profit,

privately funded system

• Night-watch officers

• Volunteers

• often slept and drank while on duty

• mostly to look out for fellow colonists

engaging in prostitution or gambling

• put on watch duty as a form of

punishment

• Boston, MA 1st publicly funded,

municipal police force (1838)

Fire Fighting

• Pre Civil-War Era -> Private

Enterprise

• Private fire brigades competed with

one another to be the first to

respond to a fire

• Insurance companies paid brigades to

save buildings

• No insurance = No Protection

• Cincinnati, Ohio – 1st municipality

w/ professional fire department

(1853)

Public Education

• Puritans in Massachusetts, circa 1647, 1st

public, tax funded schools

• Not popular outside New England

• 1779 Thomas Jefferson promoted public

education in Virginia

• 19th Century

• Growing cities – public education necessary

• Rural farming deemed formal education

unnecessary; benefit from child labor

• 1930’s and beyond

• Public schools entrenched nationwide

• Funded mostly by property taxes

1913 Municipal Budget – Red Bank Borough

1957 Municipal Budget – Red Bank Borough

$9,242,100 Salary & Wages - Regular

$1,079,287 Salary & Wages - Overtime

$1,725,131 Pension

$3,048,000 Health Benefits

$790,618 Employment Taxes + Other Benefits

$15,885,136 Total Labor Costs

$15,184,847 Total Operating Capital (Other) Expenses

$31,069,983 Total Municipal Operating Budget

Gross Domestic Product (GDP)

GDP = C + G + I + NX

C = Consumption

G = Government Spending

I = Investment

NX = Net Exports

Source: Federal Reserve Bank of St. Louis

Source: Federal Reserve Bank of St. Louis

Disease produces own cure

• Car purchase for Average

American

• 1908: Work 4,700 hours

purchase Model T

• 2008: Work 1,365 hours for

mid-priced car

Disease produces own cure

• Growth American Economy

• 2%/year natural growth

• 8xs larger in 100 years

• 60% GDP Health-care still

much more $ to spend on

everything else

GDP Trend - Government (G)

Source: Federal Reserve Bank of St. Louis

Government consumption expenditures & gross investment (G)

1947 Q1 2020 Q2

Federal 67% 39%

State & Local 33% 61%

Job Outlook

• “Bright Outlook”

U.S. Department of Labor

O*NET - nation's primary source of occupational

information

• 4 - 10% Projected growth (2018-2028)

• Accountants

• Auditors

• Assessors & R.E. Appraisers

• 11%+ Projected growth (2018-2028)

• Financial Managers

• Cost Disease

• there is nothing that can be done to stop it

• disease migrates to the public sector

• American Economy

• 70% economy consumer based

• more $ available for & greater demand of local

gov't services

• Long-Run Wages & Employment:

• stagnant productivity, wages still grow

• bright outlook gov't finance

Summary

Peter O’Reilly, MBA, CMFO, CTC, QPA Red Bank CFO

Definitive Guide to Local

Public Finance in New Jersey,

available at: njcmfo.com

peter@njcmfo.com