Scots politicians are facing their biggest test since devolution

PUBLIC sector workers are not responsible for the recession. Most of the blame should lie with regulators, bankers, governments, economists, auditors, credit rating agencies etc. But the UK and Scottish economies have changed radically as a result of the recession. UK output has fallen by 6 per cent and it may be several years before it recovers to its 2007 level. Real incomes and wages will almost inevitably fall.

The UK budget deficit in 2009-10 is likely to be about 170 billion. At 12.6 per cent of GDP, the only OECD countries with comparable deficits to the UK are Greece and Ireland. Ireland has already introduced swingeing public sector cuts and the Greek government is trying to coax its citizens to pay more taxes and stop rioting.

The UK has a better credit rating with the markets, so the need for a response is less pressing. But cuts in public spending are inevitable: the only question is when.

The Scottish Government will not be exempt, but how much its budget is cut depends on how the UK government allocates the pain within Westminster, and on whether the Barnett Formula survives the election and a possible change of government. If Scotland shared the pain with the rest of the UK and Barnett survived, cuts in excess of 3bn would be on the cards.

The Scottish Government will spend 35bn in 2010-11. Much of this will go to paying the 500,000 public sector workers financed by the Scottish Government.

The largest groups are NHS employees (161,000) and local authorities (305,000 including police and fire service). In 2007-8, employee costs in local government came to 6.8bn – around 22,300 per worker. This may seem low, but reflects the relatively low wages of some of these workers and the fact that a third of them are part-timers, compared with only 22 per cent in the private sector.

Yet many other workers rely on public spending but are not defined as public sector employees.

Much of the voluntary sector depends on local authority funding. The proposed 1 million cut in Edinburgh City's support for charities will affect many workers who do not see themselves as part of the public sector. This may not be fair, but probably reflects the reality that teachers are better placed to protect their conditions of employment than care workers with a voluntary organisation.

If the Scottish budget is reduced by 3bn over the next four years, public sector pay and jobs will suffer. But cutting public sector labour costs by 1 does not mean that the same amount is cut from the budget deficit – every 1 cut from the Scottish Government's labour costs reduces income tax, employer and employee national insurance and pension contributions.

Calculations by the Institute of Fiscal Studies show that as a result, Treasury revenues will fall by 38p, so only 62p has really been cut from the deficit. This suggests that the scale of cuts required to meet the FRA may be even greater.

Balancing pay and jobs must be one of the least desirable tasks on the planet. If the budget is fixed, more of one means less of the other. But it looks unavoidable over the medium term. To avoid decisions being driven by political expediency, it is therefore important that the masters of St Andrews House have the best information on which to take the tough decisions.

The recession has widened the gap between private and public sector wages, reducing the incentive to work in the private sector. This is certainly not sustainable given the budgetary position. For public sector employers working with declining budgets, the choice between employment and wages must principally be driven by the quantity and quality of the services provided. Better pay may attract or retain better workers. But more employment at lower wages may still provide a more effective service.

But many of the wages and conditions in the Scottish public sector, including those for doctors, nurses and civil servants, are outside the control of the Scottish Government.

Strangely, the issue of how public sector salaries are determined has never been a hot issue in the debates on the powers of the Scottish Parliament. Thus the salary review bodies for doctors, nurses and civil servants determine pay and conditions for the UK as a whole. Successive Scottish governments may have avoided this issue because of its political sensitivity. This was not problematic while budgets were expanding; large pay increases were common. But now it may reduce the ability of the Scottish Government to respond flexibly to the austerity budgets heading its way.

Ireland may not control its currency, but it does control its public sector pay. And it has moved decisively. The Irish Government brought in large increases in taxes in April 2009 and followed these in December 2009 with more tax hikes and cuts in public sector pay.

The Irish approach has been to adjust pay rather than employment. Ireland has around 360,000 public sector workers – around one-third less than Scotland in relation to its population. But the pay cuts have been very unpopular: there have already been a number of strikes and more are planned.

Our politicians need to realise that this kind of controversy is heading our way. Scotland needs to learn from the experiences of others since the recession now poses our political class with the greatest test that they have faced since devolution.

• David Bell is professor of economics at Stirling University