It’s Time to Take Public Sector Pay Rises out of the Hands of Our Politicians

This article appeared on UK Telegraph Today on September 15, 2017.
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How much of a pay rise should a manager in a small sales company in Bolton receive this year?

The Labour Party demands pay be raised across the whole public sector. Some Conservatives, led by Michael Gove and Boris Johnson, similarly advocate  loosening the current public sector pay cap, which has restricted public sector pay to 1pc annual increases since 2013. Other Conservative MPs have equal certainty about keeping the cap, claiming any loosening is unaffordable.

Of course, the difference between the sales manager and public sector workers is that taxpayers fund the latter. Government must consider what taxpayers are willing to finance. We know, from calculations undertaken by the Institute for Fiscal Studies, that even an additional 1pc increase in across-the-board public pay levels would cost taxpayers approximately £1.5bn. With the UK still running a budget deficit, savings have to be made somewhere, so why not continue to restrain growth in the £150bn public pay budget?

Conservatives are right to point out that any new spending must be financed by taxation or borrowing. But it’s important to put choices in context. Since 2010 the Tories have ring-fenced and increased a whole  host of spending on pensioners, healthcare, aid, childcare and, later, defence and aspects of the schools budget. It is these decisions that have resulted in arbitrarily bearing down on public sector pay to hit spending targets.

The result of sustaining this cap has been predictably more damaging as time has elapsed. A host of employment areas, not least nursing and prison officers, are reporting staff shortages. There is no mechanism to cope with ever-changing demands. That’s why this week we have heard government commitments to make the pay cap more flexible – a game of whack-a-mole to solve the problems the cap itself created.

Yet, just as shortages show too much pay restraint in some sectors, Conservative spending hawks are surely right that in some regions taxpayers have been overpaying public sector workers relative to a market wage. Much like the debate about gender pay gaps, we only have crude averages to review here. But in 2015-16, public pay was, on average, 14pc above the private sector, or 4pc once you control for qualification levels and a range of other factors. This gap would be higher still if we considered differences in pension provision, and greater public sector job security. Given pay scales are determined nationally, the gap would be even larger still if assessed regionally.

Not that we know what that gap should ideally be. In markets, pay is determined by the interaction of supply and demand, and people’s wages influenced by their skill levels, experience and productivity. So-called “compensating differentials” also play a role, with a premium often seen for dangerous work or having to travel to undesirable workplace locations, for example.

We do not have the knowledge of all public sector work broken down by local labour market, sector and performance — so aggregating to judge whether average public pay relative to private is “fair” is impossible. What thinking about the information lost in these statistics does highlight, though, is the problem of crudely capping nationally-determined pay levels. Such a policy ignores both sectoral needs (such as demands on the health service) but also local conditions. It means continued over-payment by taxpayers for certain roles in certain regions, and underpayment leading to shortages in others.

Ironically, both can end up costing taxpayers money and lowering the quality of public services. Overpaying is overtly wasteful and encourages decent workers in poor areas to give up more productive private sector jobs for public ones. But a ceiling that prevents government employers from paying more to fill shortages leads to more stressful work, encourages exit from the public workforce and necessitates the use of expensive, lower-quality agency workers to deliver services. Decades-old research found this phenomenon was responsible for increased death rates from heart attacks in the South of England, where the problem was most acute.

Scrapping the cap and using Pay Review Bodies, as some suggest, can ensure pay is set high enough to avoid shortages. But it’s the national nature of pay-setting that leads to the other problems of overpayment and localised damage to the economy. If the Prime Minister truly wanted to make public sector pay-setting more economically efficient, she would remove the pay cap but with the quid pro quo of abolishing national bargaining too.

Sweden shows the way. Individual workers have contracts with their local government employer. If replicated here, an individual school or local hospital trust would be free to vary pay to attract or retain a decent maths teacher or to cope with new demands at A&E, as they saw fit from their own budgets. Councils likewise could set pay in line with the general economic conditions of the local economy. In this way, devolving pay decisions would, over time, improve the efficiency and quality of public services. Abolishing the cap would be a short-term down-payment for improved economic performance and better public services.

For just as I do not know what a sales company manager in Bolton should be paid, I wouldn’t trust Theresa May to know better than the business owner either. So why not trust the Bolton NHS Trust, rather than a politician or pay body in Whitehall, to assess what to pay a Bolton nurse?

Ryan Bourne

Ryan Bourne occupies the R. Evan Scharf Chair for the Public Understanding of Economics at the Cato Institute.