Relative Prices, Always and Everywhere
Alex Tabarrok has an excellent post out on Marginal Revolution: Massive Rent-Seeking in India’s Government Job Examination System
It is an excellent post, and I agree with every single word. But the last sentence in the post is something I'd like to elaborate upon.
A Recap of Tabarrok's Post
But first, a TL;DR of his post (supplied by Gemini):
In a post on Marginal Revolution, economist Alex Tabarrok argues that the Indian economy suffers from a severe distortion caused by the massive overcompensation of government jobs compared to private-sector alternatives. He contends that this premium—which can make a public sector job five to ten times more valuable over a lifetime—creates a destructive competition where millions of India's brightest young people waste years of their productive lives studying for exams instead of contributing to the workforce. This immense "rent-seeking" not only represents a tragic loss of human capital, with societal costs potentially exceeding the value of the jobs themselves, but also leaves the state unable to afford enough workers to function effectively. Tabarrok concludes that the only genuine solution to this deep-seated problem is to bring public sector pay back in line with the country's economic fundamentals.
Please do read the whole thing, of course.
That Last Sentence
The only real solution is to bring public sector pay back in line with economic fundamentals.
The equalization of rates of return is an idea deeply loved by us economists, and I am of course no exception.
Here's a simple toy model to explain what this means in practice. Imagine a world where there are only two types of jobs possible: public sector jobs, and private sector jobs. Assume that the rate of return is far higher for public sector jobs. If you are part of the labor supply in such an economy, what will you do?
You'll want to work in the public sector, of course. As will everybody else. And so the number of people looking to join the public sector will go up, and the number of people looking to join the private sector will go down. Now, if we lived in a world where simple supply and demand stories worked, life would be good, and neither Prof. T nor I would have to write these blog posts.
Because in that simple world, wages in the public sector would trend downwards (too many applicants, not enough jobs), while wages in the private sector would trend upwards (too few applicants, too many jobs), and voila, rates equalized, and everybody lived happily ever after.
Three Little Problems
Ah, but three things that prevent this from happening:
Folks who get into the public sector will work on keeping their status, their power and their ability to set the rules for themselves. Sociologists refer to this as in-group/out-group theory, and that is very much at play here.
Folks who get into the public sector can also make sure that the other group does not rise in status. That is, they have the incentive to make sure that rates of returns remain lower in the other sector - and again, this can be achieved by favoring your own group. But it can also be achieved by not favoring the other group, and this can be done in a million different ways, some major, many not so major. Onerous regulations that are impossible to comply with is one obvious example that is explicit, very real, and for all of us, all-too-familiar. But the best way to learn about this is to spend time with any person engaged in business - and this is true regardless of whether the business is selling pakoras on the street, or building out a nuclear power plant.
In such set-ups, who you know matters much more than what you can do, and solving for this equilibrium at the individual level further ossifies this structure. That is, if all individuals optimize for who they know rather than what they can do, the societal impact of this is to have "who you know" become even more important over time.
And so if you ask me, the only real solution is to bring net public sector pay back down in line with economic and social fundamentals, and to bring net private sector pay back up in line with economic and social fundamentals.
And to be clear, when I say "net" I mean economic and social returns. And the reason this matters is because adjusting wages is actually the easy bit. Changing culture? That requires the deployment of truly extraordinary forces.
But forces that have the ability to get this to actually happen tend to be exogenous in nature, and the transition isn't a smooth and orderly one.
Ask the British aristocracy about how things went for them after WWI.
Homework: how should one think about this today, in 2025?