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Moving towards more efficient public sector pay

3 June 2011

10:57 AM

3 June 2011

10:57 AM

Data issued yesterday by the Incomes Data Services indicated that average pay
settlements over the first quarter of 2011 in the public sector were close to 0 per cent. However, pay settlements in the private sector were closer to 3 per cent. Does this mean that Policy
Exchange were wrong in a recent report to conclude that public sector workers are overpaid compared to their private sector counterparts?

The basic answer is no. We highlighted that on a range of measures, workers in the public sector were overpaid compared to their comparators in the private sector. Even on our most conservative
measure, which accounted for compositional differences in terms of age, location, hours, gender and qualifications, this gap was around 9 per cent. This means that even if these average pay
settlements continued at 0 per cent and 3 per cent for the public and private sectors respectively for the next two years, there would still be a significant pay premium to working in the public
sector. And this is even before we consider the much higher value of pensions, longer holidays and better working hours and conditions in the public sector.

So what should we make of these figures? We feel that they should be seen as good news for both the public and private sectors. A tick up in pay settlements in the private sector can only provide
positive news on productivity and business prospects. And a key way to protect jobs in the public sector is through pay restraint: lower spending on public sector employment can come through less
people or lower pay. This means that a moderation in pay settlements in the public sector should provide vital breathing space for departmental budgets and hopefully less need for job losses.

Does this mean that the pay freeze is a success? In broad terms yes: it is fulfilling its goal of reducing pay increases in the public sector. But we argue that it is too blunt a tool to really
start to tackle the wider problems in the public sector. In particular, it treats all of the public sector the same no matter where they live or what their income (apart from the lowest paid who
will see an increase of £250).

The matter of differences across the income distribution is key: one of the criticisms of our earlier report was that we did not look closely enough at how the gap varied across the income
distribution. To tackle this we have done more work (wonks should follow this link to get an idea of what we have done). We found
that compared to our average premium of around 9 per cent(even after controlling for compositional differences), those around the bottom 10 per cent of the pay distribution contend with a public
sector premium of around 17.5 per cent. For those around the top 25 per cent of the pay distribution, the premium was about 4.5 per cent. Even at the top of the pay distribution, the public sector
pay penalty that used to exist has now vanished.

This hints at how ineffective the pay freeze might be in the longer term. Those groups with the very largest pay premium will continue to get pay increases, while those with lower pay premiums will
face the freeze. The freeze will also do nothing to tackle the disparities in pay gaps created by national pay bargaining and a lack of performance related pay, which mean that those living in
cheaper areas and those with lower productivity see larger premiums. This is bad news for the public sector, where productivity and pay will continue to diverge, and for the private sector, where
firms looking to locate in areas needing regeneration struggle with over-inflated wage costs.

To tackle these things, the government should begin to move negotiation of wages to a more local level and properly reward more productive workers with performance related pay. This would allow
wages to better reflect costs of living in local areas and drive productivity in the public sector and the wider economy as wage costs in cheaper areas are brought down.

Matt Oakley is head of economics and social policy at Policy Exchange

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