The Hidden Costs of a Government Shutdown

A government shutdown is possible in the US this week if Congress does not pass a funding bill by 30 September. While last-minute showdowns between lawmakers over government funding are starting to seem routine in the US, the consequences of shutdowns are anything but routine, according to research by University of Virginia Darden School of Business professor Christoph Herpfer.

It has already been tumultuous year for the federal government, which has so far seen a loss of more than 300,000 jobs. In the case of a shutdown, hundreds of thousands of workers are at risk of being furloughed, and last week a memo from the White House instructed federal agencies to prepare for mass layoffs if the government shuts down.

The potential damage to the federal workforce and the services it provides extends beyond lost wages due to furloughs or individual worries about continuing employment, says Herpfer. Government performance suffers long-term, as well. Research by Herpfer and his colleagues uses millions of data points from government personnel files to show that  employees affected by government shutdowns experience a shock to morale that’s equivalent to a 10% salary cut. As a result, Herpfer said, thousands of civil servants leave government employment, leading to a brain drain.

The Darden Report checked in with Herpfer to learn more.

Professor Christoph Herpfer specializes in healthcare finance, corporate finance, and banking.

What are the immediate impacts of a government shutdown?

The obvious impact is the suspension of some government services, such as national parks that close. There also is usually quite a bit of media coverage about furloughed workers, in extreme cases about their financial hardships as they struggle with the liquidity shock of missing paychecks. Research has shown that, like most Americans, federal workers are not prepared for long periods without a paycheck. The median government employee has about one week’s worth of expenses in their checking and savings account around the day of their paycheck arriving, and many live paycheck-to-paycheck. This leaves little room for error.

Interestingly, while the financial hardship generates news and compelling images, ultimately these are not the things that matter the most, long-term. Employees eventually receive back pay, and services restart. The hidden costs are, well, less visible and set in later, but with more consequences down the line.

What are the hidden costs?

As you can imagine, getting sent home without pay and being used as a pawn in a political game really demoralizes government employees. That’s something so meaningful we can actually trace it in responses to government workforce surveys. These employees will return to their desks after the shutdown, but they are often demoralized and disillusioned. Low motivation does not help productivity.

In addition, the first thing many of them do when back in the office is fire up LinkedIn and look for private sector jobs. Data from LinkedIn itself confirms that phenomenon, and in fact private sector headhunters actively try to poach talent. The federal workforce is highly skilled and educated. Ultimately any large organization, be it the government or the private sector, requires similar skills and training – tons of lawyers, accountants, managers. So many of these people have outside options.

Now we are in an era in which human capital, more than physical capital, is crucial. Think about how hard large companies are trying to attract, improve and retain top talent. If shutdowns make the federal government less attractive and make it harder to hire, and if they lose valuable employees, that ultimately will have negative effects on government performance.

What are some of the shutdown effects that emerge later?

We find that there is a big uptick in federal employees leaving the government after being furloughed. Now, some people feel that the only way to shrink government size is by starving the beast, so they might like this result. But the government has important roles. It is responsible for crucial infrastructure, basic research, enormous insurance programs, etc. About one in every three dollars spent in the U.S. economy ultimately passes through the hands of the government. You want smart, capable and motivated people to handle this important work.

What we find is that a few months after a shutdown, we start to see a stream of federal workers leaving who had been exposed to the furloughs. The younger ones quit to go to the private sector, particularly when they work in areas with strong labor markets. The older ones opt to retire, particularly if they have fully vested their retirement benefits. So the workforce is bleeding both older, experienced manager types and younger, motivated employees.

One of our most interesting results is that we see the affected government agencies starting to perform less well. Now, it is tough to measure “performance” in the context of the government. The Department of Agriculture has a different job function than the Department of Commerce! However, there are some common functions across different agencies, such as representing the government in court, or making sure that payments inside the government reach the right recipients. When we benchmark the performance of agencies against each other in these domains, we find that those exposed to the shutdown and hence the loss of skilled human capital exhibit a reduction in performance. For example, their accounting departments start making more mistakes and faulty payments. Although the rate only goes up by like 1%, given how much money runs through the government’s hands, that amounts to billions of dollars in losses on that single metric alone.

The unprecedented detail of our data allow us to do some pretty neat analyses. For example, we calibrate a theoretical economic model that allows us to translate the rate of employee departure into a dollar value in terms of salary drop. We find that the shock to morale has an effect that’s comparable to a 10% drop in cash salary, which is of course an enormous amount and explains why so many qualified employees leave.

No matter your view on the government, you want it to run efficiently and well, and I am not sure whether the loss of so much human capital will ultimately lead to better outcomes.