Public Sector Wages – The Real Story

There has recently been scrutiny of public sector wage rises and the limits which have been placed on them since 2010. Most public sector workers have been subject to either a pay freeze or only a 1% pay rise per annum in the last 7 years. Allowing for inflation this has meant that variously they have seen their real wages fall on average by 12% over this time period.  In this blog we explain what Public Sector Pay Review Bodies are and how their remit has been curtailed since 2010, what has actually happened to public and private sector pay over the last 13 years and why we should not just consider pay but also pensions and other parts of the remuneration package – or Total Reward.

The Public Sector Pay Review Bodies

A third of all public sector workers are subject to the recommendations of the public sector Pay Review Bodies (PRBs): Armed Forces (AFPRB), Senior Salaries (SSRB). School Teachers (STRB), Doctors and Dentists (DDRB), Police, NHS workers (NHSPRB), and the Prison Service. Other public sector workers (mainly civil servants and local government officials) are not subject to the recommendations of the PRBs. These PRBs are made up of independent experts who, on an annual cycle, for the occupation in question, take evidence about: demand and supply conditions in the occupation, the extent of shortages, recruitment and retention issues, what is being paid in comparable jobs in other sectors and the evidence on inflation and cost of living changes and unemployment patterns.  Each PRB then makes an annual recommendation on pay uplift to the government – which in times gone by was unfettered by the constraints of government direction.  Since 2010 this pattern has changed as each PRB has been given a remit letter which determines what the pay rise will be – subject to the fiscal constraints of government spending. So in the past these independent experts made recommendations based on the evidence  – coming up with a recommended pay award which took objective account of all the evidence.  However, since 2010 these PRBs have effectively been told what the answer was – namely 1% with little scope to give advice to the contrary.

The reality of this system is that – when left to the experts we know from the evidence that: they could be trusted to come up with recommendations which were objectively fair and not out of line with what was happening in the private sector or in the Non-PRB public sector.  The real value of this process was that the PRBs provided objective advice which all parties – including trade unions, members of the occupations and the government department in question could see was based on impartial objective evidence.  The system was first introduced in the Thatcher administration to at least partly cope with strikes and difficult difficult wage negotiations in times of high inflation.

The Actual Story of Public/Private Sector Pay

The real pattern of wage increases in the public sector is that wage increases in the public and private sector tend to follow each other with a lag. It is best to consider public/private sector wage comparisons in terms of wage increases as any analysis based on levels of actual pay is frought with comparability problems. On average public sector workers earn more than private sector workers – but they typically have very different jobs with different qualifications and years of professional  training. These complexities are abstracted from if we consider changes in pay rather than the absolute level of pay.

 Figure 1 graphs the year on year growth in average weekly earnings in the two sectors by month and compares it to the basic level of price inflation as measured by the RPI.  Prior to the recession public and private sectors each had a time of relative advantage. In the post recessionary period all wages were falling in real terms as the RPI was higher than wage increases in both sectors. For most of the post 2010 period, public sector pay has grown more slowly that inflation and private sector pay.  Hence real wages have been falling.  The picture is best seen in Figure 2 which graphs the cumulative loss of value of real wages in the two sectors from 2010.  We can see that public sector workers have lost around 12% of their pay in real terms since 2010.  The corresponding fall in real wages in the private sector is 2% (although the seasonality of the private sector average wage does create an annual jump which should be ignored).

Total Reward and Pay Drift

There are some important complications to this story.  Firstly, public sector jobs tended to have: longer holidays, shorter working hours, less chance of redundancy and better pensions.  Until recently most public sector pension schemes have been based on a final salary (defined benefit) schemes which gives retirees some fraction of their final salary based on their years of service.  For example, Civil Servants used to have a scheme which was in 60ths – so that a worker serving 30 years could retire on half their final pay.  In contrast private sector employees where more usually in defined contribution (DC) schemes where they pay the same fraction of their earnings into a pot each year and the total is then used to buy an annuity on retirement.  Typically these schemes were much less generous. In compensation, many comparable jobs are more highly paid in the private sector than their counterparts in the public sector.  So there was a ‘compensating wage differential’ paid to private sector employees in recompense for their worse conditions of service.  Typically private sector workers are paid more earlier in their career but suffer later on and particularly so into their retirement. The position is summarised in Figure 3 which shows how graduates in the public and private sector fare over the lifecycle. Clearly the private sector graduate does much better in their early career – but the public sector graduate does better after around the age of 50. All this means that simple wage comparisons are not sensible. What needs to be done is to factor all compensation conditions into the calculation of ‘Total Reward’ – i.e. the value of pay and pensions and conditions of employment over the whole life cycle. This was was what done in a published paper in 2012[1].  This paper showed that broadly speaking the old system of DB in the public sector and DC in the private sector, by retirement were of equal value for men, but for women, the public sector scheme was clearly more advantageous than the private sector scheme.  Since the Hutton  pension reforms both men and women in the public sector have been made worse off than their private sector counterparts.

Since this time there has been huge pension reform and most DB schemes have gone and been replaced by Career Average schemes championed by Lord Hutton. So we now have a situation where public sector workers no longer have ‘gold plated’ pensions. This is happening to the younger generation of newly minted nurses and teachers who are graduating with debts of £40-60k.  So this same generation with large student debt and receiving lower wages and will get lower pensions in the future.  They are also the generation which will pay for the large budget deficit into the future. David Willets book called ‘The Pinch’ described this phenomenon in some detail. It is somewhat ironic that he then became the man to implement £9k annual student fees in the last coalition government!

A second complication is that in many occupations there is an increment scale which most employees advance  up each year giving them a pay enhancement.  This was not part of the 1% pay rise which has been talked about as the public sector ‘pay cap’.  So for a young teacher rising up the increment scale (from point 5 to 6 on the main scale in London) could mean a pay rise annually of 8.5%. So – in effect – their pay was not capped.  The problem comes when we look at the older worker who is stuck at the top of their pay increment scale – since they do not get an increment their nominal wage rise is capped at 1% and in real terms this means their pay has been shrinking.  Taking the mix of workers who do get increments (other than cost of living rises) and workers who only get their 1% explains why – on average – public sector pay has risen by more than 1% for most years in Figure 1 – this difference is called ‘Pay Drift’.

What Should be Done?

What to do?  Firstly, if you have PRBs making objective expert advice about pay then you should leave it to them and take their recommendations.  If, as a government, you want to call the shots and determine public sector pay rises centrally then there is no point in having the PRBs. But any government that wants to do this should look back at the era before they existed – and it is quite clear that there was very little room for manoeuvre and many protracted disputes with trade unions – which is why the PRBs were created.  Second, if you want to pay nurses and teachers more then voters need to understand that this needs to come from taxable government income.  Therefore if we pay them more we can spend less on medical equipment or new schools  (for example) – unless we are happy to have taxes rise to meet the cost.  Of course the other option is to run a larger deficit and expect our children and grandchildren to foot the bill.

The more nuanced point is that governments should not be tempted to raid the public sector pay pot to fund short term gains in meeting spending targets. Or at least if they do – they should not be fooled that there will not be any adverse consequences. Clearly after 7 years of severe pay restraint public sector wages are now too far out of line with those in the private sector and we are suffering recruitment and retention difficulties which cause huge problems in our hospitals, GP practices and schools.  Politicians must learn that there is no free lunch or ‘magic money tree’ from which the easy low hanging fruit of public sector pay can be filched to stave off short term fiscal problems.

This present government is pragmatic. It will reason that it is not worth allowing nurses and teachers to be paid more as it is votes that they are after and most of these people – they know –  will vote for Labour. Hence I doubt we will return to PRBs making objective unfettered recommendations in the short run.  In which case, why not be straightforward, and dispense with PRBs and have a simple public sector wide pay rise determined by central government each year.  This is what happens in France  – at least that is honest.

References:

Danzer, A. and Dolton, P. (2012) Total Reward and Pensions in the UK in the Public and Private Sectors. Labour Economics vol.19, pp. 584-594.

Dolton, P., Makepeace, G. and O. Marcenaro, O (2015) .‘Public Sector Pay in the UK: Quantifying the Impact of the Review Bodies’. Manchester School. Vol.83(6), 701-24.

The author has previously been a member of the AFPRB, STRB and DDRB. The Office of Manpower Economics is in no way connected to these private views of the author.