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Room for manoeuvre on pay

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Written by Dr Gerard Lyons

Economist Gerard Lyons argues that the Government may have some room for manoeuvre for higher pay without spooking the markets

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This is a problem that has been brewing for some time. Since the 2008 global financial crisis, the UK has become a low growth and low productivity economy, with half of workers across the whole economy in low paid employment. Additionally, parts of the public sector were squeezed by the austerity that followed the global financial crisis.

It is, though, more recent developments and the surge in inflation that has triggered the present strikes. But the scale of recent energy and inflation shocks that means the country is not in a position to match fully trade union demands. The UK, along with Western Europe, has been hit by a supply-side shock because of the war in Ukraine that will make us poorer. Plus, it is only when inflation is brought back under control that the cost-of-living crisis will ease. Inflation is 11.1 per cent. This is likely to be the peak, with it decelerating over the next year.

Crucially, in terms of the present wage dispute, the risk of higher public sector pay triggering a wage-price spiral that will push inflation up across the economy appears low. This provides some room for manoeuvre in the present dispute.

This situation is different to the 1970s. I have argued that our inflation shock is not due to a domestic economy that has been overheating and has not been triggered by higher wages. It has been caused by a supply-side pressures such as higher energy prices and, very importantly, by ill-judged monetary policy. Indeed, the day Russia invaded Ukraine, consumer price inflation was already 6.2 per cent and rising, and retail price inflation 8.2 per cent.

Average regular pay in the private sector is rising by 6.6 per cent and for the public sector 2.2 per cent. So pay across the economy is lagging inflation considerably, adding to the cost-of-living squeeze, and the gap between public and private sector pay growth is sizeable. Indeed, as the Institute for Fiscal Studies has noted, such figures make it hard to say that public sector pay is leading inflation.

Currently, there is much focus on this differential pay growth between the public and private sector. This is not always the best way to look at this issue. Although private sector pay is growing at a faster pace, the average amount people are paid across the public sector is higher.

Indeed, this led to Liz Truss’s calls early this summer for greater variation in regional pay across the public sector. Such calls had to be withdrawn, following negative public reaction. But in economic terms, there is an argument for greater regional pay variation. Also, public sector pensions are generous compared to the private sector. And there is greater job security, too.

Ideally, pay demands should be viewed on a sector-by-sector basis. Pay rises should be matched by productivity increases. It is, though, very difficult to measure productivity across the public sector since, as in the private sector, it needs to be judged alongside working practices and the need for greater investment, including in people.

The big issue is how to fund higher pay increases. The market reaction to the mini-Budget is one reason why the Treasury will be reluctant to grant higher pay awards, seeing a relaxation in fiscal policy as countering monetary policy. I think it is important to push back against those who might argue to fund this not through increased borrowing but higher taxation, as the tax take is already high and tightening fiscal policy even further into a recession makes no sense.

The Prime Minister said higher public sector pay demands would cost each household £1,000. This appears to include the three per cent average pay rise already factored in, not just new wage demands. But at the end of the day, whether one is working in the public or private sector, everyone pays taxes, on what they earn, spend and even save. Indeed, the bulk of any increase in public sector pay would soon be recouped by the Treasury, through income, VAT and other taxes. So the net cost is far less.

To help facilitate a settlement, there are a number of areas the Government can focus on.

First, because of the nature of our inflation shock, and also the extent to which bond yields have eased in recent weeks helped by government action, there may be some room for manoeuvre for higher pay, without spooking the markets, even so this may not meet union demands.

Second, the government is right to be guided by the independent pay review bodies. They examine all the evidence before making their proposal. It is then up to the Government as to whether it accepts their recommendations, which it has. But in current circumstances, one might legitimately say that the boards’ proposals may have been overtaken by events, given the extent to which inflation has risen in recent months. This may allow some scope to increase them slightly.

The present system of independent pay review bodies is preferable to the alternative, which is for the Government to sit down with unions. Beyond that, though, a question is whether the remit upon which the review bodies make their recommendations should be more focused on the need to recruit, retain and motivate staff. This is based on the present shortage of nurses and doctors, although this shortage has predated the present surge in inflation, and is explained by many factors, of which pay and working conditions are clearly important. Shortages often merit higher pay.

Third, the government can point to its credit that it has already announced in the summer a large increase in teacher pay for next year, equivalent to £2,100 on average pay. Average pay for teachers is £42,358. There is the case to go further in future years.

Fourth, when it comes to pay increases, and public sector spending more generally, the government is surely right to focus on the need for reform. Take the health sector. I remain of the view that we may wish to consider hypothecated taxes, as the public seems to accept the case for increased health spending. In my view, it would lessen the pressures to crowd out spending in other areas and need not be another way of raising the tax take if done properly.

Within the health system, as I noted in my previous column, there is a strong case for an overhaul of the complex pay structure in the NHS. This system is inflexible and its outcome is that doctors, nurses and other front line staff in competitive areas are not paid competitively, while many in areas where there are no shortages are well paid. Reforming this system should be central to the debate about pay.

Five, given the scale of the present dispute, and the wider impact they could have across the economy, there are reports that the Government is looking to tighten legislation on whether public sector workers in key sectors the right can have to strike. Certainly, the case for minimum service guarantees is understandable.

Sixth, across the public sector reward and incentives are not always aligned well, and in some instances the loss of real incomes over a sustained time means pay levels now are low. But this cannot always be addressed in one go and may need to go hand in hand with reform.

Finally, to have first class public services, people need to be well paid, but the country needs to be able to afford this. Again, this comes back to the need for a pro-growth economic strategy.

This article first appeared on the Conservative Home website and has been reproduced with kind permission from Dr Lyons.

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About the author

Dr Gerard Lyons