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Local Government Cost Disease Peter O’Reilly
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
