Bob Elliott: We need a rethink about what we pay public sector workers

We have to ask how we can deliver public services in the face of huge spending cuts, writes Bob Elliott

In SCOTLAND, one in four employees works in the public sector. This is nearly 8 per cent more than in the South-East of England, which has the lowest proportion of public sector employees, though it is less than in Northern Ireland, Wales and the North-East of England.

Within Scotland, there is substantial variation. In 2010, the share of public sector employment in Scottish local authorities ranged from 19 per cent in Aberdeenshire to 47 per cent in Orkney. The island authorities – Eilean Siar, Orkney and Shetland – all had public sector employment shares in excess of 40 per cent.

Areas with large public sectors receive large fiscal transfers from the Scottish Government. Fiscal transfers are, in principle, intended to reflect differences in current population “need” for public services and differences in the cost of provision of these services. But it is difficult to see how needs and cost differences can account for the very substantial differences.

Fiscal transfers have a large historical element. But such transfers also render parts of Scotland highly dependent on the public sector for public sector wages that form an important component of local demand. It follows that significant reductions in wages or employment in these areas could have a negative effect on demand and consequently further weaken the local economy, at least in the short run. With the squeeze on public expenditure now severe, significant cuts in either wages or employment seem inevitable, and this will hit high-dependency regions hardest.

Much recent discussion has focused on the “overpayment” of public sector employees, but is this the case in Scotland? To address this question researchers identify the difference in pay between “statistically” identical employees in the public and private sector. This difference, called the public sector wage premium, is reported by the Institute for Fiscal Studies (IFS) to be just 5.6 per cent (in terms of hourly pay) for men in Scotland in 2011. This is much lower than in most regions of England and in Wales. On the IFS evidence, there is no compelling evidence that men in the Scottish public sector are substantially overpaid compared with men employed in the private sector.

However, the same cannot be said for women, for the IFS reveals that the premium is nearly 20 per cent in Scotland. It is the largest premium in the UK. A premium between the pay of public sector employees and that of private sector employees with similar levels of training may be justified where, for example, the public sector jobs are more stressful or dangerous, though it is unlikely to account for all of the difference reported here. There is no obvious explanation for this difference in the premium by gender. It may reflect particular difficulties faced by women in the private sector in Scotland.

How much any public sector employee is paid relative to their private sector counterparts depends upon their position in the overall distribution of pay. Public sector workers at the 25th percentile on average earn 12 per cent more per hour than do those in the private sector with otherwise similar characteristics. At median earnings, the gap falls to 7 per cent, while for high earners at the 75th percentile, there is no significant difference between the private and public sector hourly wages. And how much any public sector employee is paid relative to their private sector counterpart also depends on the area in which they live. The evidence shows that average earnings in the private sector of the UK economy vary quite substantially between localities, while pay in the public sector varies much less. The IFS and other researchers have shown that, as a result, the public sector premium differs between the regions of the UK – with some of the highest premiums in Wales and the North-East of England.

No similar analysis can be conducted for different areas within Scotland because the data is not available in the detail required. However, it is known that pay in the private sector varies substantially between different areas, and when set alongside the much smaller regional variation in pay in the public sector this must mean that the public sector premium also differs between the areas of Scotland.

Using the same method to identify “statistically” identical employees in different areas of Scotland, it has been shown that the pay of employees in the private sector in three of the four major conurbations in Scotland – Grampian, Lothian and Greater Glasgow – is significantly above the Scottish average and that this is also the case in many of the local authority districts in the Central Belt and in the Shetland Islands.

In contrast, pay was significantly below the Scottish average in many rural local authorities, particularly the Scottish Borders, the Western Isles, Argyll & Bute, East Ayrshire and the Orkney Islands. Thus it seems almost certain that the public sector premium differs between areas of Scotland and is smallest, if it exists at all, in the former areas and greatest in the latter rural areas.

One explanation for these differences is that private sector employers set wages, while public sector wages are regulated through collective bargaining and review bodies. In the deregulated private sector, employers pay only what is necessary to attract and retain labour, while in the regulated public sector the emphasis is upon paying fair wages, as currently exemplified by the commitment of a number of local authorities to pay “the living wage”.

None of this is likely to change much over the next few years. A policy that imposes uniform pay restraint at all points on the pay distribution scale does nothing to address differences in wage distribution in the two sectors. Indeed, it exacerbates them because an exception to restraint is made for the lowest-paid public sector employees.

In theory the Scottish Government can influence, either directly or indirectly, the pay of the vast majority of employees in the public sector in Scotland, but in practice it has not chosen to do so. The pay of more than half of all Scottish public sector employees is set by UK-wide pay negotiating or pay review bodies that effectively determine wage rates for the UK as a whole. These include large organisations such as the NHS, police and the fire service. This means that in practice the Scottish Government has followed the lead of the Westminster government.

What might the Scottish Government do? Many of the institutions that deliver Scottish public services are now quite distinct from those in the other territories of the UK, and any further redesign and refocusing of Scotland’s public services is likely to exacerbate these differences. The Scottish Government could establish new pay-setting arrangements that allow the pay of Scottish public sector employees to more accurately reflect Scottish conditions. Models of pay-setting in Sweden and Norway offer ways forward. Sweden offers a model of individualised pay-setting within a general framework which ensures co-ordination and facilitates a degree of equity and control of wage costs, while in Norway local negotiations take place within a framework set by national-level agreements.

Very substantial reductions in public expenditure are planned for the next three years. As a result, the number of employees in the public sector is going to fall sharply. Public sector employees have already experienced very steep declines in take-home pay and they are expecting more. The question before us is how do we sustain the delivery of high-quality public services in such an environment?

Simply cutting pay is not the answer; more fundamental reform is required. We should use the next couple of years to review more fundamentally what we pay our public employees and how we pay them. Two of the issues to review are the case for separate Scottish pay-setting arrangements and the case for more localised pay. There should be no presumption that we know the answers.

The David Hume paper published this week discusses these issues and reports the evidence available to inform the discussion. But it also reveals that we have neither the detailed data nor the analysis we need to underpin robust decision-making.

• Bob Elliott is director of the Health Economics Research Unit and Professor of Economics at the University of Aberdeen. He is one of the contributors to a David Hume Institute paper on public sector remuneration in Scotland, which will be published shortly.