Thursday, March 01, 2007

Public Sector Pay

Gordon Brown today announced that he would be holding public sector pay rises to 1.9% p.a. Accoding to the Guardian,

The Department of Health said the minimum starting pay for a basic grade newly-qualified nurse will be over £19,600 from November, an increase of £479 on current rates and a 59% increase on 1997 rates.

Typical pay for doctors in their first post will be £31,578 from April and £32,087 from November, an increase of 3.1% on current rates and a 48% increase since 1997. A consultant on the minimum pay scale will get £71,822 from April, a 64% increase in cash terms from 1997, and matrons will start on around £35,700 from April, and £36,112 from November, with the potential to earn up to around £43,000 a year.

The 59% increase for nurses since 1997 equates to an average of 4.75% p.a., the 48% rise for doctors in their first post equates to an average of 4% per annum, and the 64% rise in consultant's pay equates to 5.07% per annum. All of which is pretty respectable.

The latest public sector rises are also in line with manufacturing pay. The FT reports that EEF, a manufacturers employers’ organisation, said that more than half of the annual pay rises in its sector in the quarter to the end of January were for 3 per cent or less.

Of course the unions are complaining (it's their job to do so), however the Treasury is more concerned about helping out the Bank of England, which has said they will be watching pay settlements closely, because of fears that inflated pay-rises will feed into price inflation.

This is particularly important, as the huge US economy looks like it might go into recession at the end of the year, slowing the whole global economy while they are at it - which will probably require the BoE to lower interest rates to protect us. However the bank will be unable to move if inflation is bubbling away, and the Treasury wants to prevent a situation where the bank is forced to hold interest rates high amidst a slowdown.

This isn't the first time the Treasury has leaned in the same direction as the Bank. During Labour's first term, amidst torrid economic growth, Gordon Brown firmly held down public spending, falling out with colleagues as a result. The reason was that the newly independent Bank at the time, was struggling to break the back of inflation once and for all, and history had shown that loosening fiscal policy during periods of strong growth results in inflation (notably Nigel Lawson's term in the late 80's when he loosened fiscal policy and cut taxes during a period of strong growth with disastrous results for inflation). Some of Brown's colleagues still haven't forgiven him for his decisions that first term, perhaps because they fail to grasp the economic reasons for them, but Labour's two subsequent victories were built on the resulting non-inflationary growth. Hopefully the unions will be more sensible than these silly ex-cabinet ministers.


Anonymous said...

Hi Snowflake

I was reading this article this evening and the comments on Gordon Brown made me think of our discussion earlier. I wonder if you agree with me that it presents a favorable but balanced view of the man who will almost certainly be our next Prime Minister?

Rifkind's portrayal of him rather coincided with mine and since he is much more closely acquainted, I found that rather reassuring.

Hope you like it anyway.

snowflake5 said...

Hi Peter

I read the article, and it's fair. The bit about "standing shoulder to shoulder with cool body language" certainly seems likely!

Anonymous said...

Which silly Cabinet Minister's do you mean? If you refer to Clarke he was not in the Cabinet in the 1st term when the spending freeze was going on. Also Milburn was chief secretary to the Treasury for a period so party to the spending freeze before becoming Health secretary. Do you mean other 'silly Cabinet Minister's'? Just because people are critical of Gordon Brown does not make them flawed. The Chancellor's behaviour in any number of policy issues has been frankly suspect.

Anonymous said...

This article makes little sense. The real reason for keeping public sector pay low is fiscal consolidation, which is a perfectly reasonable objective.

There is little merit in the inflationary justification. Real wage growth is historically low at the moment - hence is acting as a drag on overall inflation, which has risen largely as a result of higher energy and food prices, and some pass through of non-labour industrial costs.

And within an overall slack labour market (note that a tight labour market narrative is inconsistent with the Treasury's own 2007 and 2008 growth forecasts!), public sector pay is growing more slowly than private sector pay. The idea that public sector pay presents a particular inflationary risk at present holds no water.

Similarly, over the 97-99 period, inflationary expectations e.g. as expressed by the pricing differential on bonds were already pretty well contained. Tight public spending over that particular period was thus not particularly significant in the overall reduction in inflation that took place over the 1990s - probably had a marginal helpful impact.

snowflake5 said...

Sorry, economist, but governemnt spending contributes to aggregate demand just as much as household and corporate spending does.

When the Bank raises interest rates, they are trying to slow aggregate demand. But they can only influence the household and corporate sectors. If the govt increased spending while the Bank was trying to slow the other sectors, they would essentially be cancelling out the Bank's work,and the Bank would have to raise rates even higher.

The ECB did a paper on what would happen if the fiscal and monetary authorities didn't co-operate. I'll see if I can dig it out.

snowflake5 said...

Here's the paper:

There are assumed to be two instruments of economic policy: monetary policy represented by the interest rate; and fiscal policy represented by the public sector deficit. If short-run inflation is determined by a simple Phillips curve relationship between output and inflation, the authorities' preferences can be expressed in terms of different combinations of the public sector deficit and interest rates. In Figure 1 the Mi line shows the interest rate which the monetary authority will set for each level of public sector deficit so as to achieve price stability. The Fd line shows the public deficit which the fiscal authorities will set for each level of interest rates so as to maximise their preference for low unemployment and low inflation. Since the monetary authority is more inflation-averse, its preference will be for a higher interest rate (lower output) for a given public sector deficit. The fiscal authority by contrast will prefer a higher public sector deficit (more output) at a given interest rate. Given these preferences of the monetary and fiscal authorities, the outcome of this game will be determined by the extent of cooperation or independence of decision-making. The preferred outcome for the fiscal authorities is the point of fiscal bliss and for the monetary authorities the point of monetary bliss. So the cooperative solution would be represented by the heavy contract curve between these two points, representing a compromise between the preferences of the two authorities. In the non-cooperative case the monetary authority has one primary objective, the control of inflation; so it simply reacts to the fiscal authorities' deficit by setting the interest rate along the Mi function. The fiscal authority, intrying to raise employment by expanding the public sector deficit, will realise that this will have an effect on interest rates; so the fiscal reaction function is less steep than the Fd line. The non-cooperative Nash equilibrium will occur where the two reaction functions intersect. The result is a higher deficit and a higher interest rate than are desired by either party. The fiscal authority is trying to reduce unemployment by expanding the deficit, but the monetary authority is raising the interest rate to combat inflation.

The bit I've quoted is from page 11, and the graph is from page 12. The last time the govt tightened fiscal policy, I think they withdrew about 3.75% of GDP from the economy - which was fierce. Of course it helped control inflation, how could withdrawing that amount of money from the economy not?