Macroeconomics of Public Sector Reform

Without knowing the details of today’s deal, it is still worth thinking about the macroeconomics of public sector reform.  I will take it that the deal delivers widespread productivity growth in the public sector.

All else equal, an improvement in the quality or output of public services should be valued by the population. It is desirable that this be reflected in the measurement of GDP and various countries are attempting to capture quality and output measures for public services to this end. (The alternative is to measure public sector output by the volume of inputs – but this cannot capture productivity growth.)  The value to the population of extended opening hours, for example, should be considerable.  It would be helpful if Ireland made efforts to improve the measurement of the public sector contribution to GDP.

Next, for given levels of output and quality, an improvement in productivity means that the public sector requires fewer workers.  This expands the supply of labour to the private sector.  This will benefit private-sector enterprises, including via the attendant downward pressure on wage levels.  A cautionary note:  the initial impact of technological progress can be contractionary, since rigidities in the labour market may mean that it takes time for private-sector employment to expand to absorb the extra supply of workers.

Next, the financial savings from the reduction in public sector numbers [and/or the elimination/reduction of premium payments for some types of overtime] can be allocated in several ways:  (a) reduce the deficit; (b) increase the provision of public services [equivalently, avoid service reductions] ; (c) reduce taxes [equivalently, avoid tax increases beyond what is inevitable]; or (d) increase public sector pay levels [equivalently, partial or full restoration of previous pay cuts].

It is currently unclear about the intended allocation of savings across (a) through (d).

I further note that uncertainty in the provision of public services is damaging for the population, such that the commitment to avoid strike action and other types of service interruption is very welcome.

Finally, as part of the overall package, a commitment to no further pay reductions is also welcome by providing certainty to public sector workers  – this should reduce the level of excess precautionary savings. (I made this point back in January 2009 in my paper “A New Fiscal Strategy for Ireland”  –  the ideal time profile for pay cuts is to make a significant initial cut but not to pursue a sequential process of gradual pay cuts.) Since there are likely still significant pay premia for many public sector occupations, it will be important to closely monitor future public pay dynamics by reference to labour market conditions across the economy.

Public Sector Reform

Peter McLoone writes an opinion piece in today’s Irish Times: you can read it here.  He details the reforms that were on offer during last week’s negotiations and it is an impressive list  – the scope for substantial efficiency improvements in the public sector seems quite substantial.

In terms of analysis,  eliminating inefficiency in the public sector will help raise living standards across the economy over the medium term.  The union movement has recognised the potential for such fundamental reform and implementing these reforms would be a very positive contribution to the renewal of the economy.

In terms of the short run,  Mr McLoone criticises the deflationary impact of public sector pay cuts. Since the union movement has agreed to a target of €1.3 billion in payroll savings in 2010 (albeit with the protection of the standard hourly rate of pay), I would be interested to know Mr McLoone’s views on the  short-run macroeconomic impact of the alternative package proposed by the union movement.

In today’s edition, there is also an op-ed by my colleague John O’Hagan on public sector pay: you can read it here.