Hard choices ahead for government cutting public sector employment and pay

Published on 12 December 2013

Office for Budget Responsibility forecasts for public sector pay and employment suggest continuing cuts to public employment and large squeezes in pay relative to the private sector. Our analysis suggests that public sector pay relative to private sector pay will now return to its pre crisis level in 2013-14, two years earlier than implied by past forecasts. Forecast squeezes to public sector pay up to 2018-19 would further reduce the public-private pay gap below levels last seen in the early 2000s, when parts of the public sector had difficulties recruiting and retaining staff.

After the 2013 Budget, the Office for Budget Responsibility (OBR) forecast that general government employment (that is employment by central and local government) would fall by 1 million between 2010–11 and 2017–18. However, with the Chancellor choosing to pencil in further cuts to departmental spending in 2018–19, last week the OBR suggested that a further 130,000 general government jobs would go in 2018–19, bringing the total fall to 1.1 million by 2018–19.

Despite the scale of these cuts, it was not the reductions in government employment that really stood out in the OBR’s latest forecasts. Instead it was the reductions to forecast growth in public sector pay. Public sector pay is now forecast to be 3.6% lower in 2017–18 than expected in June, when our analysis used the OBR’s March forecasts and incorporated an estimate of the effect of the 1% pay award in 2015–16. This change of view in part reflects the fact that earnings growth in the public sector has been weak so far this year, with no growth in pay in the 3rd quarter of 2013 compared with the same quarter a year before. This has led the OBR to reduce its forecast for public sector pay growth in 2013–14 to only 0.5% compared with a forecast of 2.2% in March. It has also reduced its forecast for each year up to 2016–17 compared to the March forecast.

At the Spending Round in June, based on the forecasts then available, we showed that the headline public-private pay gap was likely to return to its pre-recession level by 2015¬¬–16. As can be seen in Figure 1, this was after public pay had grown faster than private pay during the recession. The latest forecasts now suggest an acceleration of the fall in public pay relative to private: the pay differential is predicted to return to its 2007–08 level (and the level seen in 2008–09) this year – two years earlier than previously forecast. Furthermore, OBR projections imply that public sector pay is set to grow less quickly than the private sector in each of the years after 2013–14 too. This implies that by 2018–19, public sector pay is predicted to be 6.4 percentage points lower relative to private sector pay than it was before the crisis in 2007–08.

Notes: Data to 2012–13 estimated using Labour Force Survey data. Forecasts based on authors’ calculations using OBR Economic Fiscal Outlook March 2013 and December 2013. “Forecast June 2013” incorporated an estimate of the 1% pay award in 2015–16 announced in Budget 2013.

The recent trends in average public sector pay relative to private sector pay do not appear to be driven by a change in the composition of the workforces. The green line on Figure 1 shows that after we control for observed differences in individuals’ age, sex, experience and education, following a similar methodology to our previous analysis, the trends in the differential in recent years are little altered. Of course, controlling for the observed differences, the ‘conditional’ differential is lower than the average raw premium, as public sector workers are more likely to be highly educated and in professional or similar roles. More details on this latest analysis are available here.

If, as these projections suggest, public sector pay is set to fall relative to private pay by 8 percentage points between 2012–13 and 2018–19, it seems likely that public pay will fall lower relative to private pay than its level in the early 2000s when parts of the public sector had difficulties recruiting and retaining staff. This has some important implications. First, if the current forecasts are correct and private sector earnings growth continues to be higher than public sector earnings growth, some public sector employers may well find it increasingly difficult to retain and recruit high quality workers. Second, if that leads the government to want to mitigate the squeeze in public sector pay but to keep workforce costs as planned it would have to absorb even more cuts to the size of the workforce, beyond the cuts of more than 1.1 million already planned between 2010–11 and 2018–19.

In making such decisions, both the government and pay-review bodies need to pay great attention to indicators of whether the public sector is facing any difficulties in recruiting and retaining high-quality staff, and decide on settlements in light of any such evidence. While public sector pay relative to private sector pay was forecast to return to its pre crisis level by 2015–16, squeezing public sector pay may have been a relatively easy way to cut departmental spending. Given the current OBR forecasts, the choices ahead for the government now look rather harder.

This analysis has been developed during an ongoing project funded by the Joseph Rowntree Foundation, to whom we are grateful for support. Over the next year, we will seek to publish further analysis of changes to the public workforce and public sector pay.