Ed Holmes: Time for a more mature debate on public sector pay and pensions

Ed Holmes is Senior Research Fellow for Economics and Social Policy at Policy Exchange.

‘With his insatiable greed was never willing that his treasuries should be depleted... he tried to fix by law the prices... sheer necessity led to the repeal of the law’.

Large swathes of the public sector will be striking today – many for the first time since the Coalition came to power. No doubt the Chancellor’s announcement of a mandatory two year 1% pay cap on the public sector – on top of the existing two year freeze - will add to their ire. As with the quote above (actually from the fourth century scholar Lactantius about the Emperor Diocletian rather than the TUC), such freezes never have and never will last forever. Like all price freezes, the public sector pay freeze entrenches inefficiencies which ultimately lead to collapse. In this case, it reinforces national pay bargaining, meaning that in some parts of the country, the public sector is considerably overpaid, stifling private sector recruitment and growth.

Trade unions have argued that the freeze should be scrapped. Ultimately there is no doubt that it will be. We are already seeing its partial decay through ‘get rounds’ such as bigger bonuses and temporary promotions. But pay restraint will at least help to get our deficit down and protect public sector jobs. In fact, new analysis from Policy Exchange shows that pay in the public sector is not only more generous, but the pay premium when adjusted for factors like education, gender and region has actually risen since the freeze came into force. This equates to an additional 9% on average, or 16% towards the bottom of the income distribution. A private sector employee working full time on around the minimum wage would be around £2,000 worse off a year compared to a public sector worker with similar characteristics (age, gender, qualifications and region). But none of this deflects from the fact that pay freezes are a very blunt tool. More significant for long-term reforms was the Chancellor’s announcement of a review by the Pay Review Bodies of regional pay bargaining by July 2012. This is something Policy Exchange has long advocated; we believe this should lead to defining localised paybill pots to be allocated at a transitionally regional and ultimately individual level reflecting local living costs and staff performance, following the Swedish model. This would boost productivity, growth and regional re-balancing.

The other part of this story is public sector pensions – which are also far more generous. The supposed main cause of tomorrow’s strike is changing the measure of inflation by which public sector pensions are increased each year from RPI (Retail Price Index) to the less generous CPI (Consumer Price Index).

Inflation affects us all in different ways: what and how we choose to spend, save and borrow. The real question is what is the best reflection of the real cost of living – and there’s a serious debate about whether RPI and CPI are better for this.

CPI embodies changes in price-based preferences based on price: or, to give it its wonky description, it embodies elasticity effects better than RPI. But it doesn’t include housing and council tax (though it may do at some point in the future) and was never designed as a true price inflation measure. The government would have a case that pensioners, like the rest of us, substitute goods based on price. It’s also true that many pensioners have paid their mortgages off. In any case, this is really incidental to the main issue, which is that the vast majority of private sector pensioners do not have their income linked to the cost of living and have seen their stakeholder pensions’ value tumble in recent years. Ultimately, we will have to address the unfairness at the root of this disparity – the more or less segregated system of defined benefit public sector pensions and defined contribution private ones.

So public sector pay and pensions are very generous. This is indisputable and the trade unions do themselves no favours by denying it. But it’s not enough for the government just to keep repeating this. We need to move to a model of public sector and of engagement between unions and government that is much more collaborative. A pay freeze and changing the pension inflation measure might provide temporary solutions, but bold reforms to achieve true fairness cannot be put off forever. Both unions and the government need to reflect on that fact.