Freezing almost four million public sector workers’ pay in cash terms means cutting it in real terms if prices rise, which will leave teachers, soldiers and police officers with less disposable income to spend. So does the policy risk stifling demand and thus hindering the UK’s economic recovery?
The Centre for Policy Studies says the announcement, expected in the Spending Review on Wednesday next week, is “necessary and fiscally responsible”. The think tank argues that private sector wages are falling by comparison, and that “there is a need to control public spending and reduce the structural deficit, which the pandemic is likely to have opened up”.
As Ben Zaranko, research economist at the Institute for Fiscal Studies (IFS), notes: “In a recession, it’s a good time to be a public sector worker. You’ve got more job security and job stability. In some cases, these jobs might be seen as being higher status than they once were.” Overall, the IFS expects the freeze will save the Treasury £3.4bn.
Historically, public sector wages have grown more slowly in economic booms and faster in busts. In the financial crisis, for instance, the public-private sector pay ratio fell, before rising in the subsequent decade.
This has been the same during the pandemic: data from the Office for National Statistics (ONS) shows public sector pay rose more quickly from July to September – by 3.7pc annually – than private sector pay, which added only 0.8pc.
The furlough scheme has driven the discrepancy, with many private sector workers earning only 80pc of their normal wages.
Increased demand for certain types of labour, such as in healthcare or administration, may have also contributed.
Overall, employment by the state has risen by about 300,000 since the first quarter of this year, while private sector employment has fallen by almost 800,000, according to the ONS.
How much a pay cut would affect state-employed workers' consumption depends on whether it would prompt them to dip into their savings, built up while they have been restricted from indulging on foreign holidays and eating out.
“To the extent that lots of public sector workers are relatively high earners, you might think that they have built up savings that they could use to prop up their consumption,” Zaranko says.
However, regardless of whether there is a public sector pay freeze, private sector wages will continue to fall, reducing overall demand, Hande Kucuk, deputy director of the National Institute Of Economic and Social Research, says. A public sector pay freeze could exacerbate this trend, though, by encouraging private employers to follow suit.
Moreover, if the idea behind the policy is to help to pay for Covid spending, Julian Jessop, a research fellow at the Institute of Economic Affairs think tank, asks: what’s the rush?
“The extra debt taken on to pay for the pandemic doesn’t itself have to be repaid because it can be rolled over by selling new government bonds as old ones mature,” he says.
“Of course, the Government still has to pay interest on this debt but borrowing costs are currently very low and the Treasury gets some of these payments back anyway from the Bank of England.
“Even if interest rates do rise soon, the long average remaining life of UK gilts – about 15 years – means that cheap borrowing is locked in for an extended period.”
For Kucuk, freezing public sector wages might not have a significant effect on the economy’s recovery, but likewise, the effect on the public sector finances would be “mostly just a signal”.
She stresses that fiscal support should not be withdrawn until the recovery strengthens: cutting investment or withdrawing the furlough scheme would have a more harmful effect on the recovery than freezing public sector pay.
Nonetheless, the move could damage future public sector recruitment. Targets to hire teachers have been missed for eight years, for example.
Zaranko says: “Even if some people think it’s not fair to give public sector workers a pay rise, if you can’t attract enough teachers then perhaps something has to give.”