Fiscal Policy

More on Fiscal Adjustment

I have written an article for today’s Sunday Business Post on the economics of public sector pay cuts: you can read it here.   Although Karl is correct in saying that public sector pay cannot be the sole factor in the fiscal adjustment, it is clearly the most contentious issue in terms of the range of views that are being expressed.

8 replies on “More on Fiscal Adjustment”

Good article….bur contains within it the seeds of the problem

“Accordingly, in negotiating with a union movement that cares about the quality and level of public services, in addition to the pay and conditions of its members, the government should be able to negotiate public sector pay reductions (plus efficiency-enhancing reforms of public sector service provision) in exchange for the preservation of a given level of public service provision. This would not be feasible if the individual trade unions cared only about the wages of their own members and did not take into account the impact on the overall public sector in making pay claims.”

Do we have any evidence that such a broader view is in action? From my discusions at times with senior tu’s they “get it” in principle but can see no way or need or urgency of communicating it in practice. Im sure some smarter person can do a game theoretic analysis of why that is. But tis. Hence, my view is as expressed last week that the state walk from social partnership.

Philip, this is an excellent analysis and I accept the case you make in your article for public sector pay cuts at this time. I think there are two issues which need further exploration. One is whether such reductions in pay rates should be graduated, with smaller cuts on lower earnings. The other issue concerns the legal and institutional mechanisms to achieve this objective.

The case for graduated reductions has both economic and political elements. We are not talking here about the revised Fine Gael proposal that pay cuts would only affect salaries over €100,000 per annum, this clearly goes nowhere near achieving the pay savings which would help to protect public services at this time (as well as causing complicated threshold effects for salaries just under €100,000). From an economic perspective, if we think pay levels should have something to do with matching supply and demand, the issue is whether the public sector pay premium varies by pay level.

This issue was investigated in the Boyle, McElligot and O’Leary 2004 QEC article They found that the distribution of earnings in the public sector was much more compressed than in the private sector, with a much lower coefficient of variation for average monthly earnings. They noted that the difference reduced over the period 1994 to 2001, largely because slower growth in private sector high salaries due to skilled immigration led to greater compression of the private sector distribution over this period. Nonetheless, for 2001, they found that for earnings at the 10th percentile from the bottom the public sector premium was 17%, falling to a range 8-9% at the 75th and 90th percentiles. In other words, lower paid workers were paid relatively better in the public sector than higher paid workers. These relativities may have been modified but hardly reversed in the benchmarking process, suggesting that the case for graduating pay cuts in the public sector on economic grounds is weak.

There remains the political argument that some gesture towards graduation could be an important factor in reducing opposition to the proposal. The other side to this argument is that, the more significant the gesture, the harder it becomes for the government to meet its pay savings target and the greater the ‘headline’ reduction has to be to compensate.

The second issue concerns the legal and practical issues involved in revising existing pay contracts, both in civil service and in the more important public sector (teachers, nurses, guarads, etc). Are there any views on how this could be done?

My, my. And here we see a fine example of the propellerhead economics pundits that got us into this mess.

How exactly does cutting pay for public servants (in the context of a public hiring freeze) affect the relative wages that prospective private sector employees are willing to accept? What we have here is just the latest attempt in a long war by the Free Marketeer cultists to hobble the State, and I would hope that our democratically-elected politicians are able to see through it.

I’d be impressed if I saw a screed here calling for sacrifices among the elites in this country, rather than us PAYE plebs. I am guessing that restraint is a one way street for the boss lobby and their cheerleaders in academia.

Stimulating piece.
The Report of Benchmarking II (December 2007) contains a wealth of detail on public service pay structures and public service pensions that will, I hope, inform the debate. These are available at:
A point that needs to be taken into account is that the net impact of cuts in public service pay on the budgetary situation would be significantly less than the gross due to the consequential loss of tax revenue. With marginal income tax rates of 20% and 41%, income levies of 1% and 2%, and PRSI of 6.5% on public servants hired since 1995, revenue would fall by maybe as much as €30 for every €100 cut from public service pay. And this takes no account of further loss of indirect tax revenue from reduced consumption. These effects would significantly diminish the fiscal impact of cuts in public service pay.

Brendan’s contribution highlights two key issues. If we believe that cutting public sector pay would have no positive impact on the rest of the economy, his warning about the loss of tax revenues should receive a full weighting. However, if public sector pay cuts are helpful in promoting economic recovery, there are some pluses as well as minuses to consider.

Also, this point suggests that the scale of public sector pay cuts needs to be sufficiently large in order for the net fiscal contribution to be meaningful.

Responding to Alan’s point, I would certainly agree that some level of discrimination between higher- and lower-paid public sector workers is appropriate. Again, this points to cuts for the higher paid that would be larger than the 10 percent level that is in circulation as an average cut.

Nice piece Philip. I think politically it would be really helpful if the main reason for wage cuts right across the board were presented more in terms of the need to simulate a devaluation, hence addressing the employment crisis, rather than in terms of the need to address the government fiscal crisis. The fact that it does that also should be regarded as an additional benefit: this is about the only policy that helps address both crises simultaneously. The devaluation argument is not a divisive argument, anything but: it enables you to see the need for coordinated action right across the economy, with a possible role for government and social partnership (if the latter is up to the job–we will soon find out) in bringing about the adjustment as smoothly and equitably as possible.

EWI: I would bet that the vast majority here would be in favour of immediately ending all remaining tax reliefs for rich people. But while that will make a modest contribution towards solving the state’s fiscal crisis, it won’t help prevent the mass unemployment and emigration that is now staring this economy in the face. Wage cuts, and related measures such as breaking the ESB monopoly, will.

I would bet that the vast majority here would be in favour of immediately ending all remaining tax reliefs for rich people. But while that will make a modest contribution towards solving the state’s fiscal crisis, it won’t help prevent the mass unemployment and emigration that is now staring this economy in the face. Wage cuts, and related measures such as breaking the ESB monopoly, will.

Measurable impact or not, the government and the rest of the scolds lining up in the press and on the TV each day – the same class who led us to this very precipace, just as they did in the Eighties – are rightfully going to be told to go take a hike until and unless they can demonstrate some real bona fides. I don’t harbour any illusions that (for example) certain high-profile media owners will be made to contribute their fair share, but there is a whole class of less prominent personalities below those free-market deities who need to put their shoulders to the wheel first in taking some strong medicine. A good start would be in our ludicrously large and overpaid political class.

Too many of us in the PAYE class remember Hair Shirt Charlie being revealed years after the fact to be Charvet Shirt Charlie. What guarantee that the same sleight of hand is not being pulled again, and Seán Fitzpatrick is just the one who has been caught out?

As to “breaking the ESB monopoly”, let’s hear what you’re proposing. If it’s just another Eircom fiasco, though…

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