Be a bold reformer, George: end national pay bargaining for individuals' pay in the public sector

by Ryan Bourne

A recent study of successful fiscal consolidations suggested that the spending adjustments often occur amidst a more general ‘pro-reform’ stance of the government, on the supply side as well as the spending side.

Nowhere is that supply-side more important as the public sector. And no one supply-side policy would do more to liberalise the public sector than to abandon national pay bargaining – an incomes policy that leads to a great deal of inefficiency across the provision of public services, whilst entrenching regional inequalities.

Of course, the unions have started the scare stories on what ending national pay bargaining could mean, and it is understandable that the public are wary. Brendan Barber has suggested that this will worsen school and hospital provision in poor areas. Other trade unionists, and even some Conservative MPs, have suggested that the policy must entail a long pay freeze for public sector workers in those areas, meaning less prosperity in those regions, with knock-on effects for other employment.

It’s understandable that big centralised unions are worried. The big losers from abolishing national pay bargaining will be big centralised union leaders, who get huge political authority and power from their high-profile public negotiating. But the example of Sweden shows that unions need not suffer hugely from reform, and that, actually, local unions can thrive.

The whole trade union argument is, in fact, attacking a straw man. Abolishing national pay bargaining does not mean you have to have regional pay bargaining and across the board pay freezes in poor areas. Nor does it mean that pay will still be set by central government. In fact, one of the more bizarre arguments against bargaining at a regional level is that it will mean poor localities within regions will find it more difficult to obtain good staff. Well, I never! Imagine what the consequences would be if you did it on a national level!?

What’s more, the unions and the wary Conservative MPs are seemingly defending an indefensible status quo. The UK is marked with regional disparities, with attempts to boost areas by shifting public sector employment there failing spectacularly to raise the prosperity of the regions. On the contrary, recent academic research suggests that public sector employment (especially with relatively high public sector wages) significantly crowds out manufacturing employment.

The economic case for reform of the way pay is set is blindingly obvious. Having pay scale negotiations between union leaders and central government cannot possibly help create an efficient labour market, because it gets nowhere near capturing all of the supply and demand factors which would normally determine wages.

This can have significant effects on the economy and public services:

• It damages private enterprise in poor regions: Poor areas which suffer from high unemployment, in the absence of national pay bargaining, would tend to have a cost advantage over other national regions. Provided there are reasonable skill levels, this should encourage private sector companies to locate there and over time create jobs. But national pay bargaining means private sector firms have to pay the wage premium that will inevitably result from above-average wages on offer in the public sector in poor areas, therefore undermining any competitive advantage. We would therefore expect, as is the case, that poor areas with high public sector employment have the lowest rates of overall employment, as the public sector crowds out private enterprise.
• It limits flexibility for poor localities within poor regions and rich regions: Of course, this can result in some better services for the better off individuals in poor regions. But the poorest localities in poor regions suffer. It is obvious that sometimes it will be necessary to pay more to attract teachers, for example, to teach in the most difficult localities in poor regions. But national pay bargaining prevents this. In poorer localities in richer regions, this problem is compounded by the attractiveness of the alternative of higher private sector wages. Where local private sector wages are high, recruitment is much more difficult and large numbers of expensive agency staff are needed to fill the gaps. Academic research has shown how damaging this can be. Either way, those obtaining public services in poor areas suffer.

All of this is set out in detail in Alison Wolf’s excellent CentreForum publication ‘More than we bargained for’. And contrary to the trade union claims that abandoning this madness would result in huge regional wage cuts, there is a solution that (whilst not creating immediate cash savings) would lead to a much more efficient labour market over time, in line with the experience of Sweden.

This entails abolishing collective bargaining for individual wages and instead introducing individual contracts, which would be reviewed each year. This allows managers genuine flexibility in the creation of new posts, and in the redefinition of what individuals jobs involved. It would liberate them to enable pay to reflect more accurately local conditions, whilst being able to offer attractive wages to fulfil difficult posts. What’s more, it would not entail automatic immediate or prolonged wage cuts, but would work through over time, with the end result being the elimination of the damaging effects outlined above. It would decentralise union power, without (as the example of Sweden shows) severely damaging worker protections.

When the case is set out as brilliantly as Alison Wolf and others have done, it seems a no brainer. The vested interests of the centralised unions will no doubt resist, but this supply-side reform could lead a hugely important positive legacy for the UK labour market. As part of a pro-reform agenda, George Osborne must not miss the opportunity.