Public sector pay and pensions are why the deficit stays high

Why can’t the UK government get its deficit down? This question has been exercising commentators recently, in the light of the latest assessment from the Office for Budget Responsibility (OBR) that George Osborn will once again miss his target for the deficit in the 2014/15 financial year. Of course, the size of the deficit has fallen, from the £157 billion which Labour bequeathed in 2009/10 to £108 billion in 2013/14. But it does just not fall as much as either the OBR consistently predicts it will or the Chancellor would like it to. This limits the ability of the government to deliver tax cuts in advance of the election next year.

A common, and plausible, reason is that there has been a shift in how the economy operates. Output has recovered strongly, but earnings have not. The bargaining power of employers is stronger, many members of the workforce have a more flexible attitude to how much they work, so take home pay rises remain below inflation. As a result, the amount of tax flowing into the government’s coffers is not as much as would be expected on the basis of evidence from previous economic recoveries.

But the fundamental reason is that remuneration in the public sector remains too high. The recent strikes by Unite and other unions show that many people on the conventional Left seem to believe that the purpose of public expenditure is to boost the private consumption of those employed in the sector. The continued existence of annual increments in much of the public sector has no counterpart in the private sector. In the latter, pay increases have to be earned. In the former, for many workers they are automatic.

An argument which is used to justify the gap between pay in the public and private sectors is that the level of qualifications of public sector workers is on average higher. This is entirely spurious. What counts is not what goes into the production process of an organisation, but what comes out at the end. Countries in the former Soviet bloc, especially the East European satellites, had high levels of educational attainment. But the quality of much of what they produced was very low. The Trabant, for example, was a very popular car made in the old East Germany. But once trade with the West was opened, its value fell to essentially zero.

Gordon Brown started off well as Chancellor. He kept us out of the Euro and kept a grip on public spending. But he began to have delusions in the early 2000s that he had solved the problems of boom and bust and could do anything. Brown started to stuff money into the pockets of Labour’s core vote in the public sector. The result was that a structural deficit emerged in the UK’s public finances before the crisis of 2008 struck. Any Chancellor who is serious both about fairness and about eliminating the deficit needs to cut make serious reductions in public sector pay and pension entitlements.

Paul Ormerod is an economist at Volterra Partners, a visiting professor at the UCL Centre for the Study of Decision Making Uncertainty, and author of Why Most Things Fail: Evolution, Extinction and Economics.