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Can the UK government afford to increase public sector pay?

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The UK government’s refusal to improve its pay offer to public sector workers has led to a head-on collision with unions, with a wave of strikes set to disrupt key services in the run-up to Christmas.

As nurses and ambulance crews prepare to join rail workers, postal staff and border officials on the picket lines, prime minister Rishi Sunak said existing offers were “reasonable and fair”, while ministers maintained they could not be more generous without jeopardising the public finances and the fight to bring down inflation.

“It is high inflation that is eating away at people’s wages and that is why the government must take the tough decisions needed to support the Bank [of England’s] mission,” a Treasury spokesperson said, adding that any deviation from this would “stunt . . . long-term economic growth”.

But economists say that squeezing public sector workers is a political choice, not a necessity — and that paying NHS workers better could bring wider benefits to the economy.

Are workers paid more in the private or public sector?

Average earnings excluding bonuses in the private sector have risen 6.9 per cent over the past year, according to the latest official data — far too high for the Bank of England’s liking as it battles to bring inflation back to its 2 per cent target. But public sector earnings have grown just 2.7 per cent — lagging by one of the widest margins on record.

The government argues that this year’s pay awards, which vary by workforce but are in the region of 5 per cent, represent the highest uplift the public sector has seen in 20 years. But the Treasury has warned that these awards are higher than allowed for under current spending plans, implying that next year’s pay award could be lower.

The pay awards also fall far short of inflation and follow a long period in which austerity policies have eroded the premium public sector workers used to enjoy over their private sector counterparts. Research by the Institute for Fiscal Studies think-tank shows that public sector workers earned 3 per cent less on average than peers in the private sector in 2021, once bonuses were included.

They still did better overall if generous public sector pensions were taken into account, but Ben Zaranko, senior research economist at the IFS, said this would be “of little consolation” in the current cost of living crunch, since they would have lower take-home pay in the short term.

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As a result the government is losing workers to the private sector, where employers are more willing to raise wages in order to combat labour shortages and help staff cope with cost of living pressures.

Can the government afford to pay public sector workers more?

Jeremy Hunt, chancellor, has argued that raising pay in line with inflation for all public sector workers would cost taxpayers some £28bn — or £1,000 to each household.

This calculation assumes an 11 per cent pay rise in 2023-24, for an expanding workforce on top of this year’s pay award.

Economists say this is misleading. Unions are disputing this year’s pay deal, not next year’s, and the government has already factored pay deals in the region of 4 to 5 per cent into its spending plans.

Zaranko said that if the government wanted to deliver a double digit pay increase in the current fiscal year, the additional cost to the exchequer would be closer to £10bn, given workers would pay some of it back in tax.

However any meaningful increase would be unaffordable on current spending plans. “The government has minimal headroom against its fiscal targets. It would have to be accompanied by higher taxes,” Zaranko said.

Would a higher public sector pay offer stoke inflation?

In theory inflation-busting pay deals could fuel inflation. If the government offered workers double digit pay rises without offsetting them through higher taxes, it would be injecting more money into the economy, adding to inflationary pressure.

But public sector wages are currently lagging so far behind the private sector that there is little risk of the government setting any precedent for more inflationary pay rises by business.

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Tony Yates, an independent economist and former Bank of England official, said that if a public sector pay rise appeared inflationary, the central bank could in any case offset it by raising interest rates. However, if the government funded higher pay by raising taxes, there would be no effect on inflation.

“The real objection is the ideological one, in particular the argument of the Tory party that doesn’t think [a bigger state] is consistent with conservatism,” he said.

Would higher public sector pay stunt long-term growth?

The government’s argument against public sector pay rises ignores the fact that functioning public services bring wider benefits to the economy.

There is mounting evidence that staff shortages are making it harder for the NHS to tackle lengthening waiting lists and for schools to help pupils catch up on learning lost during coronavirus lockdowns. This has long-term economic effects that could outweigh the immediate costs of raising pay.

The real question for ministers is how much they will need to pay to recruit and retain the people needed to deliver the public services voters want.

“There is a huge macroeconomic case for sorting out the NHS,” said Yates, pointing to the record number of people who said they were not in the workforce because of long term sickness. “If the money can whittle away at that . . . the net benefits could be very large indeed.”

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