by Richard A. Epstein
On September 18, 2012, the Chicago Teachers Union negotiated a settlement with the City after going on strike for seven days. At issue in the dispute were critical issues like teacher salaries, working conditions, and teacher evaluations. As is typical in these situations, neither side held all the high cards. The two parties had to agree to compromises that patched up the current difficulties without implementing any sensible long-term reforms.
The wage piece of the deal is likely to add about $74 million per year over the next four years to a municipal budget that is already deeply in the red. The extra dollars that go into wages will be taken out of other budgets, rendering classrooms and other facilities less suitable than before. The moderately stiffer standards for teacher evaluation, both before and after tenure, may make marginal improvements in teaching performance, but none that will be significant in the short term. The overall dismal performance of the Chicago public school system, with its 60 percent graduation rate, will remain more or less what it has been.
The recent news affirms that public education in Chicago and other major cities needs to be fundamentally overhauled. The first item on the reform list should be the collective bargaining system, which has taken over public education for the last fifty or so years. Collective bargaining has its roots in the private sector, where it received a huge boost from the passage of the National Labor Relations Act of 1935.
The act allowed workers to band together to select, by secret ballot, a union of their choice to represent them in direct negotiations with the employer, who was bound to negotiate with them in good faith over all relevant terms and conditions of employment. Even in the private sphere, the decision to legitimate collective bargaining was a major policy mistake whose negative influences remain manifest to this present day.
Competitive Markets, Thwarted
Left to their own devices, labor markets are highly competitive. The protection that any worker has against his employer does not rest on endless rounds of bargaining backed by the threat of strike, but in his ability to leave his job to work for another employer who offers higher wages and better terms. No firm, therefore, can keep workers at artificially low wages so long as free entry is allowed by new firms. The competitive labor market allows many small adjustments, which on average tie wage levels to overall productivity, not to the artificial scarcity created under the NLRA.
The presence of a union changes all of that. With unions, the market is no longer as competitive because the union holds a monopoly enforced by law when it becomes the exclusive bargaining agent for its members. Under competition, wages tend to converge to a single point, so that the bargaining range—the gap between the most that the employer is willing to pay and the least that the worker will accept—shrinks.
In perfect competition, which we never see, all wages are uniquely determined, so that all transactions take place virtually costlessly on a take-it-or-leave-it basis. The rate of job formation is high, and the costs per transaction are low, so few scarce resources are squandered in setting the wages and conditions of employment.
Union monopoly power expands that bargaining range. To keep it simple, assume that the employer can remain in business if it pays a wage of $25 per hour, and the workers are willing to stay employed at $15 per hour. Each side has a strong incentive to hold out for its preferred outcome, even at the cost of protracted and heated negotiations where both sides are posturing. Their bargaining threats become credible so long as workers are prepared to strike and employers are prepared to lockout workers if a deal is not reached. In most cases, these negotiations do produce a deal after both sides suffer high transaction costs, but in some fraction of cases they do not.
Advocates of the NLRA in 1935 hailed the law as a way to bring “industrial peace” to the troubled world of management-labor relations. But once the enforced labor truce of World War II came to an end, the “strike wave” of 1946 led to some important revisions of the NLRA that cut back on union power. But those changes did nothing to reintroduce competitive employment markets.
Over time, union power dwindled, not because the bargaining structure was reformed, but because deregulation and greater foreign competition left labor fewer monopoly profits to extract in key industries such as automobile and steel. With less to offer, union ranks have shrunk to, today, about seven percent of the market from a high of about 35 percent in the mid-1950s.
The Tyranny of Public Unions
Public unions have been exempt in large measure from these global changes, given that public education is run by a dominant firm—one with the lion’s share of the market that its small fringe competitors cannot displace. Today, the monopoly position of the teachers remains strong enough that they can muscle their way to a new contract.
But it is important to note the collateral damage that this bargaining process causes. There are about 350,000 students in the Chicago public schools, and each of their families had to scramble for seven days to adapt to the strike dislocations. Estimate the cost of these frantic last-minute arrangements at $20 per day per family, and the daily losses from the strike equal about $7 million per day or about $50 million for the strike period, which comes to about one-sixth of the salary gains that the teachers received.
Yet note this critical difference between the parents’ losses and the teachers’ gains. The wage increases were, at best, transfer payments from the public treasury to the teachers—a maneuvering of funds that will neither increase nor decrease the overall social welfare, given that typically a dollar in the hands of one party is worth as much as it is in the hands of another.
Progressives often challenge this assumption, but are hard-pressed to show that dollars are worth more in the hands of teachers than they are in the hands of parents. The key point is that these high wage settlements are likely to decrease social welfare if they contribute to the deterioration of the public finances of the city, making it all the more likely that it will default on its future obligations, especially its sorely underfunded pension plans. The short-term losses of the parents, by contrast, were not simple transfer payments. They were dead-weight social losses needed to repair the damage caused by the strike.
The overall social losses run even higher, given the ripple effects of the strike on third parties. These include private employers, whose routines were disrupted, and businesses and shops, which lost business.
In addition, the resolution of this episode before disaster struck is likely to further entrench the current system of gladiatorial combat between management and labor, which, in turn, increases long-term instability in the education sector in at least two ways. First, at the conclusion of this contract, the same cycle of negotiations will occur yet one more time. Second, the continued operation of the system is likely to expose the soft-underbelly of modern public finance—the underfunded pension plans crying out for reforms that union leaders, along with other public employees, resist.
The Pension Quagmire
The root of this difficulty is that both sides in public-employee negotiations find it in their interest to reduce the wage portion of the overall collective bargaining agreement—which, in the case of the Chicago public school teachers, is quite high at over $75,000 per year—in favor of larger pension benefits under a “defined benefits” plan. Such a plan places the risk of financial shortfall squarely on the public treasury.
The original motivation for defined-benefit plans is that a large financial system is better able to cushion the blow of market fluctuations than individual employees. But, in practice, the great risk to this approach is that it leads both sides to understate the cost of these liabilities by overstating the anticipated rate of return on the assets—often at a ludicrous eight percent—which are set aside to fund the program.
The alternative “defined contribution” system caps the liability of the public employer at the amount of the contribution, and then requires the individual employee to manage that fund, usually by diversifying assets, in ways that minimize the economic risks. Unfortunately, half-hearted efforts to switch future employees, and only future employees, to this plan will do nothing to avert the financial melt-down that is likely to come when these plans fail in the coming decades.
The Charter School Alternative
Fiddling with the collective bargaining system will do nothing to counter the system’s short-term political instability (from strikes) and its long-term insolvency (from excessive pension obligations). The political opposition to dismantling the public bargaining system is too ferocious to overcome. The best tactic, therefore, is to sap teachers unions of their power by supporting a competitive charter school system.
Under the charter school system, the city government continues to fund the schools but leaves separate and competing systems to run the schools and hire the teachers. This competitive environment reduces the gains that teachers get from unionization, and forces them to face savvy school administrators who know full well that unionization of their schools can easily be their death warrant. It has not gone unnoticed that during the Chicago strike, about 50,000 students continued their education uninterrupted in charter schools.
Defenders of public school teachers make the “bold progressive” case that charter school teachers earn, on average, eight-percent less than their unionized rivals. But they are wrong to think that this wage differential points to the weakness of the charter school system. The lower wages cannot count as an overall disadvantage of the system because of the tax relief that they confer on the system as a whole. In addition, it is risky to claim that lower wages impose a hardship on teachers, who often desire these coveted positions.
Further, the absence of unions means the absence of union dues and union work obligations, which together could easily account for a quarter to a half of the total wage differential. Additionally, charter school teachers do not face the risks of work disruptions through strike, with the attendant financial and emotional risks. And working in these environments has the advantage of forging more productive relations with school administrators because of the absence of restrictive union work rules that contribute to daily standoffs between management and labor.
There are today endless studies that compare the relative efficiency of charter schools to regular public schools. These reports have been used to critique and laud charter schools in equal measures. But the bottom line seems to be that for inner city students, charter schools offer some systematic long-term improvement, which accounts for the long-waiting lists of students desperate to escape the public school monopoly.
The preferred public policy should therefore allow more charters to be issued and fewer government restrictions to be placed on the formation and operation of such schools. That will in turn put greater pressure on public school systems to clean up their own acts, if only to retain students.
Such competition will also give added impetus to the generally salutary, but not transformative, Race to the Top initiative of the Obama administration, championed by Arne Duncan, himself the former head (2001-2008) of the Chicago Public Schools.
In the end, the real driver of educational reform must be competition from new entrants, blessed, not regulated, by local governments.
Richard A. Epstein, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution, is the Laurence A. Tisch Professor of Law, New York University Law School, and a senior lecturer at the University of Chicago. His areas of expertise include constitutional law, intellectual property, and property rights. His most recent books are Design for Liberty: Private Property, Public Administration, and the Rule of Law (2011), The Case against the Employee Free Choice Act (Hoover Press, 2009) and Supreme Neglect: How to Revive the Constitutional Protection for Private Property (Oxford Press, 2008).