There is an article in the Wall Street Journal on Jan 22, 2010 on claiming that public employee unions are sinking the state of California. In particular, the article singled out the generous pensions in California such as CalPERS as a major cause of California’s budget woes.
What happens if pensions are replaced with 401k-like plans?
Reform of the pay structure of public employees will be very difficult. If state and local government denies generous pensions, unions will be forced to negotiate pay raises in lieu of pension benefits. Those raises would presumably be used to fund 457 plans (similar to 401k plans). Pensions have been used by local and state government to kick the can down the road by delaying payments until retirement. But if pay raises are granted instead, that will accelerate cash flow problems that many California municipalities and the state are experiencing.
So how about freezing all employee benefits and salaries? How about firing them or laying them off?
That sounds easy in practice. And then fire the union workers when they go out on strike just like Reagan did in the 1980s. Unions could do that, or more likely their productivity will sink to new lows while staying on the government payroll. The bad economy is not going to spur many strikes.
And when the economy gets better, there will be a mass exodus of the good workers to the private sector. The good workers in government stay because of the generous retirement benefits. What’s left will be the worst employees that nobody else wants, fully protected by the unions. You won’t want to visit the DMV as they grumble about their CalPERS pension being frozen while being offered a 401k that is not able to keep up with inflation.
The current pension liabilities are legally binding, with the exception of California declaring bankruptcy, which would rock financial markets around the world with California notes, bonds, and pensions going bust. In bankruptcy, you cannot cherrypick which obligations you wish to pay and those you don’t want to pay. This means California is stuck with their problems. The current liabilities are here to stay.
What is the solution then?
The unions in California are very powerful. 2/3 of the state legislature is Democratic. The chances of fixing California’s budget problems by changing the compensation structure is very small. The only thing that will work is layoffs, which are allowed in nearly all union contracts. But that will require a reduction in services, which may not go over well with the Democratic legislature. But that may not be a choice if the financial markets and the US government refuses to loan money to California anymore.