Public sector pay, real wages and productivity

The government announced on Tuesday 12 September that they were to relax the cap on public sector pay. From 2010 to 2012 there was a freeze on public sector pay, since then pay rises have been capped at 1% per annum. In the corresponding period CPI inflation has risen at a faster rate. Between Jan 2010 and April 2017, Office for National Statistics (ONS) figures show that average nominal (or money) wages for government employees has risen by 10.9%, while the CPI index has risen by 17.2%. We can work out the effect on their real wages by using a simple formula: % change in real wages = % change in nominal wages – the rate of inflation. Using the figures above you should find that there was a 6.3% fall in the real pay of those in the police, health service and not forgetting teachers. Private sector employees have also suffered a fall in real pay, but by a lower amount of 2.5%

There are 2 problems with public sector pay. One is that it is constrained by political considerations affecting government fiscal policy. The government is still committed to reducing the budget deficit and balancing the books. Increases in pay necessarily mean a cut in a different area of public spending. The second problem is due to the nature of public sector employment.

If you are working for a profit making private sector company, you might expect there to be some relationship between your pay and the profitability of the company. Banks have been renowned for paying out large bonuses to their staff, apparently as a result of good performance. Retail sales staff may receive a bonus for achieving a target level of sales. Microeconomic theory also demonstrates that there is a link between productivity and wages. Given a downward sloping marginal product curve, firms continue to employ workers up to the point where the Marginal Revenue Product of Labour (MRP) = Wage. An increase in the productivity of labour will mean that each worker is contributing more to firm`s revenue and profits and is therefore justified to receive a higher wage. If a Ford factory can increase production from 100 cars a week to 110 cars, worker productivity has risen and so should their pay!

However in the public sector it`s much harder to measure productivity. How do you measure the productivity of a nurse or a teacher when there is no real physical output? Governments have attempted to link productivity to pay in the public sector by introducing rewards and incentives into the pay structure, but often these are based on very subjective criteria. Ultimately then public sector pay is at the mercy of government policy. Independent pay review bodies now advise the government on suitable pay rises. However there is no statutory obligation for the government to act on their advice.

A recent report from the NHS pay review body was highly critical of the government and recommended changes to government policy and an end to pay restraint. We know that with a lifting of the cap, police offers will effectively receive a 2% rise in pay, while prison officers a 1.7% increase. With the threat of a winter of industrial action and inflation likely to rise above 3%, there are soon likely to be more announcements for other government employees.