A new approach to public sector pay vital for recovery

Third, a commitment to a clear medium-term fiscal strategy can help in supporting economic recovery, since uncertainty about the level and composition of taxes is a deterrent to investment and the location decisions of highly mobile workers.

Fourth, it is important that details of the medium-term strategy are settled as soon as possible, since the international evidence indicates that it gets increasingly difficult for governments to make tough economic commitments as the date of the next general election draws closer.

Building in resilience

A basic problem in setting out any medium-term fiscal strategy is that the prospects for economic growth remain quite uncertain. To this end, a core objective should be to improve the resilience of Ireland’s fiscal position in the event of future downturns. In particular, a new approach to the setting of public-sector pay rates is highly desirable.

Rather than committing to irrevocably fixed pay schedules (a commitment that could only have limited credibility given recent experience), an explicit two-part pay structure would balance the importance of stable incomes for public-sector workers with the need for fiscal flexibility.

Such a two-part pay system would guarantee the vast bulk of agreed pay rates (subject to meeting productivity and reform targets) as secure “Part A” pay, while reserving the option to cancel or hold back a portion of “Part B” pay in the event of a specified decline in macroeconomic performance.

The guaranteed nature of “Part A” pay would allow public-sector workers to conduct financial planning without the trauma imposed by the “unexpected” pay reductions imposed during this crisis, while the conditional nature of the “Part B” pay component would recognise that the macroeconomic risk facing the country has to be borne to some degree by public-sector workers.

Negative alternatives

The alternatives to such a limited form of pay flexibility are either costly fluctuations in public-sector employment or excessive tax volatility.

In contrast to the current Croke Park agreement, the trigger for any such pay adjustments should be explicitly specified to allow for external third-party monitoring and forestall any disputes on the meaning of the agreement. One of the lessons of the euro crisis is that national macroeconomic stability inside a monetary union requires new instruments to replace the traditional policy option of currency devaluation. This two-part pay strategy can play an important role.

If successfully introduced in the public sector, this type of pay system might also be adopted in domestically exposed industries in the private sector that face similar macroeconomic risks.

In formulating the medium-term strategy, the Government also needs to take seriously the advice of the Fiscal Advisory Council that the deficit should be reduced more quickly than is envisaged under the current plan.

The sizeable risks attached to high public debt (especially given the prevalence of high sovereign debts in other countries and vulnerability to contagion crises) should not be underestimated. The Government has delivered much in terms of economic adjustment; it is important that it does not declare victory too early.