FT Debunks Brown's Pay Cut Argument

Interesting article from the good old FT yesterday. Sure, it might be (might be?!) a bosses' journal, but it gives some useful insights at times, and this is a good example. It debunks New Labour's main argument for the public sector pay cuts, which of course then begs the question: what is their real reason? Teaching the workers their place, you think?

[Hat tip: Patrick]

The puzzle of PM's wage stand
Financial Times Thursday April 3rd

By Chris Giles

Published: April 3 2008 03:39 | Last updated: April 3 2008 03:39

The reaction of economists to Gordon Brown's continued insistence that public pay restraint is vital to keep inflation low tends to be a collective scratching of heads. The link between public sector pay rises and inflation is generally thought to be weak.

No self-respecting economist would argue that public sector pay does not matter, but they believe that the effect is generally felt in the cost and quality of public services, not in inflation.

The main reason public sector pay is only weakly linked to inflation relates to the financing of public services, which tend to be free at the point of use. Schools, hospitals, the police force, the army and even refuse collection are financed from taxation, not from direct charges to users. So there is no direct mechanism for higher nurses' pay, for example, to be passed on to higher charges for healthcare services.

In fact, the inflation index is comprised of goods and services that are almost entirely provided by the private sector.

Stephen Nickell, head of Nuffield College, Oxford, told the Financial Times in January that public sector pay rises "have nothing to do with inflation".

Mr Brown's emphasis on public sector pay can therefore relate only to indirect effects of public-sector pay, either on private-sector wages or on demand in the economy. But economists are sceptical, since employment in the private sector dwarfs that in the public sector by roughly four to one.

Martin Weale, director of the National Institute of Economic and Social Research said recently: "What I really can't believe is that, when private sector pay rises are 4 per cent, a rise of 2.5 per cent for the public sector is inflationary."

Even Mervyn King, governor of the Bank of England, played down the link in his inflation report press conference in February when he was generally stressing the need to combat inflation.

Public sector pay settlements "affect the tone of the labour market as a whole and will have an effect on the likely path of private-sector settlements in due course", he said.

"But that's a matter for government. We have never set out to say either for an individual company or a sector what the pay settlements should be or what pay growth should be."