Why has hiring been so strong? States, cities are finally boosting pay and adding workers

The U.S. job market has shown surprising resilience this year, despite the Federal Reserve's interest rate hikes and high inflation. One significant factor contributing to this resilience is the government sector, especially state and local governments, which have added 379,000 jobs in the first half of 2023. This comprises nearly one-quarter of the nation's 1.7 million payroll gains, even though federal, state, and local governments make up just 14.5% of total employment.

This trend marks a departure from last year when states and localities struggled to compete with the private sector, which offered larger pay increases and remote work options due to severe labor shortages. In response to long-standing challenges, many states have taken steps to address these issues, such as implementing pay raises, hiring bonuses, and other strategies.

During the April-June quarter, total compensation for state and local government employees, including pay and benefits, grew by an average of 4.9%, with wages and salaries increasing by 4.7%. These figures surpassed the gains seen in the private sector and reversed the dynamic from the previous year, where government pay and benefits increased by just 3.4% compared to 5.5% for private workers.

Interestingly, the public sector has already surpassed the number of jobs added in all of last year, with 161,000 jobs remaining until reaching pre-pandemic levels. The private sector, on the other hand, has fully recovered from the job losses experienced during the health crisis in April 2022.

The pace of job growth has slowed somewhat, but the surge in government hiring has partially masked this slowdown. While employers averaged adding a record 606,000 jobs per month in 2021 and 399,000 jobs last year, the monthly job growth this year has averaged 278,000, which is still robust by historical standards. However, if not for the government hiring, job growth would average a solid but less robust 215,000. In June, the private sector added only 149,000 jobs.

The slowdown in private-sector hiring, coupled with the perception that private-sector employment better reflects the economy's health, could potentially impact the Federal Reserve's decision to raise interest rates as a means to control inflation and cool down the labor market.

Several factors have contributed to the recent uptick in government hiring. Firstly, there has been a slowing down of employee exits, such as retirements and quits, which spiked earlier in the pandemic. Many government workers retired early or left for more lucrative opportunities in the private sector, but the pace of this exodus has slowed as COVID-19 has receded.

Additionally, the process of approving funding for new positions and pay increases takes longer for state and local governments compared to private companies. However, now that funding has been approved, governments are accelerating their hiring efforts. Nevertheless, many job openings in the local government sector are still challenging to fill, particularly for positions like science teachers, where shortages exist due to policies that prevent paying them higher salaries despite the increased demand for their specialized skills.

Another factor contributing to the increase in government hiring is the healthy state of state and local finances. The robust U.S. economy has resulted in higher tax revenues and fees for governments, in addition to the federal stimulus payments they received during the early days of the COVID-19 pandemic.

Moreover, private companies have scaled back their hiring efforts as the economy has slowed, which has reduced competition for workers in the government sector. At the same time, more Americans have returned to the workforce after leaving it during the pandemic due to various reasons like caring for children or health concerns. The share of adults working or actively seeking jobs was at 62.6% in June, which is below the pre-pandemic level but higher than the previous year.

Lastly, state and local governments have become more flexible in their work arrangements, gradually embracing work-from-home options and flexible hours. This change in policy has allowed some rural communities that have struggled to find workers to attract job candidates by offering remote work opportunities.

Looking ahead, if the economy and job market experience the expected slowdown later this year and in 2024, public-sector hiring is projected to continue being a source of strength that will contribute to overall job growth. However, some analysts caution that a sputtering economy could lead to softer revenue and hiring for state and local governments as well. The sustainability of recent pay raises may come into question as state tax revenue has already started declining.   

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