The Public Sector Pay Non-Deal

In the absence of reliable information on the details of the proposed deal, an overall evaluation is not feasible.  However, there are several key issues to consider in interpreting the deal that wasn’t.

At one level, it is remarkable that the broad parameters of the required fiscal adjustment seems to have been accepted on all sides,  such that there was a common overall objective. This should not be taken for granted and is a tribute to the social partnership process – it is possible to envisage ‘alternative universes’ in which the union movement adopted a more rigid attitude and failed to take into account the overall macroeconomic and budgetary situation. This also provides hope that a deal may be feasible in the future.

However, there are some fundamental problems with the union position.  The main point of resistance seems to be that the hourly rate of standard pay  (or pay per ‘unit of effort’) should not fall. Under this approach, beyond the savings from proposed changes to normal working hours that should lead to considerable savings in overtime payments, the balance of the required adjustment has to take the form of a reduction in aggregate work hours.  The decline in aggregate work hours can be achieved through some mix of unpaid leave (the focus of the plan for 2010), the continuation of the recruitment embargo and the various other schemes that have provided incentives for individual public sector workers to reduce the level of work hours.

On RTE radio today,  Mr Begg justified the use of ‘short time’ working by citing its prevalence in private sector adjustment in Ireland and elsewhere. However, there are some major differences. First, ‘short time’ working and partial capacity utilisation in the private sector is typically deployed in response to a decline in demand for the output of the industry or firm in question  – it makes no sense to continue a high level of production if there has been a substantial downward shift in demand, since over-supply will just drive down prices and/or reduce profitability.

In contrast, there is no such downward shift in demand for public services in Ireland (indeed, if anything, there is chronic under-supply of public services in many lines of activity). Accordingly, it is not appropriate to deploy ‘short time’ working as a general adjustment measure in the public sector.

Second, the level of public services can be better protected by achieving a decline in the hourly rate of pay – the more can be done in terms of a downwards shift in the pay rate, the more aggregate work hours can be delivered. In this way, in combination with extensive public sector reform, the prospects for transformation of the public sector would be enhanced by a decline in the pay level.

Another argument that has been applied in opposition to a pay cut in the public sector is that pay cuts are not so prevalent in the private sector.  However, many of the real and nominal rigidities that deter pay cuts in the private sector are the result of the highly-decentralised pay process in the private sector, leading to an inefficient response to macroeconomic shocks.  Indeed, that is a core rationale for activist monetary and fiscal policies – the decentralised market outcome leads to excessively high unemployment in response to adverse shocks.

These conditions do not hold in the public sector, especially under coordinated pay bargaining  – the union movement and the government should be able to internalise the overall macroeconomic environment and recognise that a pay cut can be the efficient response to negative macroeconomic developments and offer a superior outcome to the alternative of undesirable reductions in aggregate work hours.

Moreover, the distributional impact of pay cuts is more attractive than the alternative by allowing the maintenance of a higher level of public sector employment, rather than shifting the burden of adjustment onto those public sector workers whose contracts expire and those will be frustrated in their plans to pursue public sector careers by a recruitment embargo.

As I have repeatedly written about,  the necessity of downward wage flexiblity is essential for small member countries of a monetary union.  Negative macroeconomic shocks will often require a real devaluation in order to restore full employment:  inside a low-inflation monetary union, this can be achieved at lowest cost in terms of unemployment through a reduction in wage levels.  The idea that wages can only be adjusted upwards is not sustainable under EMU.

It is also important to appreciate that a resistance to wage cuts during the current crisis will also carry long-term costs for future pay settlements in the public sector.  In particular, a forward-looking government should be very reluctant to grant significant pay increases in the future if there is no ‘escape clause’ by which wage gains can be clawed back in the event of a large-scale negative shock.

Finally, the focus here on public sector pay should not deflect attention from wider policy issues.  In relation to attaining real devaluation,  a deal with the public sector unions that enables improved productivity in the public sector constitutes another source of a decline in the equilibrium real exchange rate.  In addition, the government can do much to foster wage reductions in industries in which it exerts considerable control. Similarly, it can go further in reducing fee levels in those professions that rely heavily on the public sector as a source of demand.  More broadly, tackling monopoly power across sheltered sectors of the economy will further help to engineer widespread reductions in prices and wages.

In relation to fiscal adjustment,  the public sector paybill represents only one dimension of the overall adjustment. Other spending categories face considerable cuts, while the tax/GNP ratio will have to rise considerably in the coming years.

The scale and multi-dimensional nature of the economic and fiscal crisis does call for a collective effort in its resolution.  As such, social partnership still has a lot to offer – however, an insistence on the ‘nominal fetish’ of no reductions in the rate of pay is not helpful.