Prospects for the UK’s economic recovery look slightly brighter this week. The IMF doubled its growth forecasts from those set only last April. This is good news for everyone and shows that growth is not incompatible with holding down government spending. But problems remain on the horizon in terms of an overreliance on consumption, continued deficits and ultra-low interest rates. Perhaps most importantly, the recovery has not yet reached those parts of the country that need it most. The proportion of workless households exceeding 30% in some areas while improvements in growth and living standards remaining anemic in many regions.
The government will be looking for ideas on how to generate growth more evenly and to rebalance the economy. One often overlooked area to achieve this is reforming the setting of pay in the public sector. This has a huge impact. Public pay is the equivalent of 12% of the entire economy – around £180 billion a year. Some reforms are in the pipeline for school teachers, the NHS and to remove automatic pay progression based on length of service, as we at Policy Exchange have previously recommended. But in general, pay is still set by centrally determined salary scales, which operate regardless of the cost of living, performance or the local labour market. This is very ineffective. It causes overpayments for some workers and underpayment for others. Overall, our new paper out today, Public and Private Sector Pay: 2013 update, shows that, controlling for a wide range of factors, a typical public sector worker benefits from a 6.1% pay ‘premium’, earning around £1,400 more than an equivalent worker in the private sector.
This may sound like a simple question of fairness – but the problem runs deeper. Where salaries are too low, the public sector can struggle to recruit and retain the right staff in high cost or disadvantaged areas, leading to higher fatality rates in hospitals and worse exam results in deprived neighbourhoods.
Changing this system will not be easy – and areas which have high overpayments have understandable reasons to be wary of reform. These overpayments have had a big role in making transfers to these regions: some £6.3 billion. Simply returning this money to the Treasury would likely hurt some local economies.
We believe there is a better solution. By ringfencing savings from areas of the country which would otherwise lose out, we can target this money more effectively at growth-enhancing investment rather than additional consumption. Even on cautious estimates, we show that at least 288,000 additional jobs could be created – the equivalent of over a quarter of people claiming unemployments benefits in some regions. This would be a big boost to local economies struggling the most in the aftermath of the financial crisis.
Getting public sector pay right will not be easy and the government has made a good start. But to spread growth and jobs across the country, we will need to go further in reforming this vital part of our economy.