As federal gravy train ends for D.C. area’s economy, it’s time to plan ahead

Steven Pearlstein
Columnist December 31, 2011

Washington has a lot to be thankful for as we enter the new year.

Since 2007, the region’s economy has grown by about 14 percent at a time when the national economy has expanded by about 3 percent. According to Stephen Fuller, my colleague at George Mason University and the go-to guy for statistics on the regional economy, growth here has exceeded that of every other metropolitan region.

Steven Pearlstein is a business and economics columnist who writes about local, national and international topics. View Archive

A fair reading of Fuller’s most recent report suggests that most of that growth — perhaps all of it, once the typical multipliers are applied — has been the result of rapid increases in spending by the government.

In the past decade, for example, federal employment increased by 50,000, more than erasing the declines of the Clinton era. More significantly, federal procurement spending over the decade grew 166 percent, to $80 billion from $30 billion. With less than 5 percent of the nation’s population, the region captures 17 percent of the federal payroll and 21 percent of procurement dollars.

It’s been a wonderful ride, not just for the past 10 years but the past 20, and it has helped make ours one of the richest regions in the country. Which makes it all the more painful to have to inform you that it’s about to come to an end.

Any reasonable scenario for the future would surely project federal spending on salaries and procurement to grow very little, if at all. Given the region’s lopsided reliance on those types of federal spending, it’s a pretty good bet that the regional Washington economy will grow slower than the rest of the country for an extended period of time.

The reversal is unlikely to begin this year or even next — there’s a lot of built-in momentum to federal contracting and employment. Nor will we really know the extent of the federal pullback until several months after the coming election. Even the anticipation of a slowdown, however, is bound to have a self-fulfilling impact. It’s time — indeed, it’s past time — for the Washington region to begin thinking about its next act.

Over the next month, I propose we begin together to do just that — I in this and several subsequent columns, you in e-mails to pearlsteins@
washpost.com
that will be shared with readers in this space at the end of the month. Please keep them relatively short and to the point. And please, spare us the “green energy” fantasies that have characterized such exercises in the past.

Given its outsize influence, the logical place to begin may be with the federal government and imagining how it is likely to be transformed over the next decade.

There’s nobody in the government who does this sort of long-range system planning, if for no other reason than it’s impossible to know what future Congresses and presidents will do. However, I’m going to go out on a limb here and predict that when faced with the prospect of big and painful cuts to the government’s operating budget, voters and politicians are going to be mighty insistent we start to get more value out of our money. And any discussion about greater productivity and accountability leads directly to an overhaul of how government hires, fires and compensates its employees.

If you look at the tremendous growth in government contracting and outsourcing over the past 20 years, it’s been driven by one political imperative — putting a lid on the total number of federal workers — and three economic realities.

The first reality is that lower-level, less-skilled government employees tend to be overcompensated relative to those in the private sector. Their pay is at the high end of the range, and that would be okay if the government aimed to recruit and retain a quality workforce, which it should. What really skews things are the benefits — health insurance and pensions — which are way more generous than in the private sector. A lot of the early outsourcing was about avoiding these higher costs.

At the same time, higher-skilled government employees tend to be significantly under-compensated relative to the private market. For this group, benefits are comparable but salaries are not, particularly given the fact that the government is not allowed to offer bonuses and stock options. Unable to attract skilled workers, the government has had no choice in many instances but to outsource the work to contractors who were free to pay market rates.

The final reality is that because of civil service rules, it is difficult — some would say impossible — for the government to fire low-performing workers or lay off large groups of workers once a project is completed. Outsourcing has been a way to work around this problem. By not having to carry as much deadwood, contractors can do work more cheaply. And while contractors fight hard for new contracts in order to keep a stable workforce, they are often forced to lay off workers who are no longer needed.

Moreover, even when good people want to work for the federal government, an arcane hiring system does all it can to stand in the way of hiring them in any timely fashion and promoting them through the ranks. That also gives private contractors a big advantage.

The intense pressure to cut spending without cutting vital services is likely to alter all of these realities and finally force the government to re-engineer the way work is done, rationalize its compensation and reform its civil service rules. And that would present a major challenge for the federal contracting sector, which has driven growth in the Washington economy. With similar hiring and firing rules and a competitive pay structure, some of the major drivers of outsourcing will have been eliminated, and it will make sense for the government to begin bringing more of its work back in-house, forgoing the cost of coordination and contract management, along with contractor profit and marketing expenses.

The only thing standing in the way of these reforms in Washington has been the sway public employee unions have over Democrats in Congress. But with Republicans likely to be in control of the next Congress and Democrats facing the prospect of deep cuts in cherished domestic programs, the political pressure for reform will be unstoppable, as it has been already in a number of traditionally Democratic and pro-union states. If federal union leaders were smart, they’d try to get ahead of the curve by negotiating reasonable reforms in exchange for the opportunity to bring more of the government’s work back in-house.

By itself, a shift from outsourcing to insourcing would be bad news for government contractors but not necessarily for the Washington economy. After all, a job insourced from SRA International to the Transportation Department is still a local job.

Unless, of course, it isn’t. For at the same time that the government is restructuring how and where work is done, there’s a very real possibility that both the government and contractors will decide to shift work away from Washington. The reason: Thanks to all that recent growth, Washington is now a very expensive place for government and businesses to operate.

Even as some of the country’s biggest contractors (SAIC, CSC and Northrop) have moved their corporate headquarters to Washington, they have quietly shifted lower-level work out to take advantage of lower living costs and pay scales elsewhere in the country. Some, like CGI, have expanded into southwestern Virginia. Others have moved along with federal clients whose offices were transferred to other regions as part of the Defense Department’s base realignment process. As the number of contracts declines and contractors come under even more intense pricing pressure, it’s a good guess that even more work will be relocated.

None of this is news to Washington’s contracting firms, which are scrambling to come up with new strategies for bolstering revenue and profit in the face of all these budgetary head winds.

As in the past, the first instinct of the big public companies will be to try to pump up their numbers through mergers and acquisitions. To the extent they are successful, that inevitably means fewer jobs overall.

It’s also only a matter of time before the Beltway boys start talking of moving into the “commercial space” and competing for private-sector contracts. Over the decades we’ve seen earlier versions of that movie, and let’s say it rarely has a happy ending.

It’s time to acknowledge that the Washington economy can’t continue to grow and prosper by hitching its wagon to the federal gravy train. That train has reached the end of the line. If we want to make further progress, we’ll finally have to hitch our fortunes to other economic engines. Some ideas on that next week.

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