Economics: What are we to make of the new pay deal? According to media reports, the draft agreement provides for a 10 per cent pay increase phased over 27 months. Initial reaction, from the union side, has been favourable with union leaders describing it as one of the best ever.
The employer side has been a bit more downbeat. Employers' body Ibec has characterised the deal as one that is "at the very limit of what the country can afford".
The relevance of the deal will vary considerably across sectors. While it is probably going too far to suggest that it will be wholly irrelevant to the private sector, the evidence indicates that pay there is fundamentally determined by market forces. Pay norms that are hammered out in Government Buildings may have some influence in the short term, but ultimately it is the forces of supply and demand that shape private sector wages.
Indeed, the notion that wage increases can be squeezed into a one-size-fits-all corset across the board in a dynamic market economy is more than a little daft.
In contrast, the deal will be universally applied across the public sector. So, all public servants can expect that, on foot of this deal, their pay will be 10 per cent (10.4 per cent to be precise) higher in September 2008 than it is now. Of course, for many if not most of them, pay will be increasing over this period for one or two other reasons.
First of all, there is the often overlooked matter of incremental scales, the effect of which is to automatically raise pay every year, typically by something in the range of 3-5 per cent. Second, there is the benchmarking process: the second benchmarking report is due for publication before the end of 2007, and it seems unlikely that it won't contain recommendations for additional pay increases to at least some public sector grades.
Taking all of this into account, a 10 per cent basic pay rise over 27 months, which equates to an annualised rate of increase of 4.5 per cent, does not seem ungenerous on the face of it. Quite how good it turns out to be will depend on how inflation evolves.
The first thing it is worth saying here is that, had the deal been done last December, the agreed pay rise would almost certainly have been lower. The reason is that the reported annual inflation rate has accelerated markedly in the intervening period, from 2.5 per cent then to 3.8 per cent in April, and the latter figure is likely to have exerted some influence, even if mistakenly, on the parties' expectations of how inflation will behave going forward.
This prompts the question of why the annual inflation rate has accelerated so sharply. An obvious culprit is interest rates, which were raised twice between December and April. The resultant increase in the cost of servicing mortgages added 0.5 percentage points to the annual inflation rate. Stripping out this effect, there is still a marked acceleration evident however: the annual rate of increase in the consumer price index excluding mortgages went from 1.9 per cent in December to 2.7 per cent in April.
Why was this? Some commentators have suggested that it was because of the behaviour of energy prices and the prices of services. Actually, these explanations are entirely incorrect. The rates of energy and service price inflation were essentially unchanged between December and April.
In fact, one of the sources of upward pressure on the inflation rate over this period was the humble spud. Potato prices are notoriously volatile: in December they were 3 per cent below their year earlier level; by April they were 26 per cent above. The behaviour of potato prices, together with the prices of a small range of other fresh foodstuffs that are also notably volatile, was such as to add 0.3 percentage points to the annual inflation rate in the first four months of the year.
Another significant source of upward pressure on the annual inflation rate over this period, perhaps accounting for 0.4 percentage points of the acceleration, was the behaviour of traded goods' prices (that is, the price of imports).
I'm not convinced I have a full handle on what's been going on here, but I suspect that exchange rate movements may have played a role. In the early months of this year, the euro was significantly weaker vis-a-vis the dollar, and modestly weaker against sterling than in the corresponding period of last year. This is likely to have put some upward pressure on import prices.
The point about this rather detailed dissection of the inflation data is that it provides a more robust basis than one would otherwise have for scoping out the prospects for the period ahead. The bad news is that upward pressure emanating from the cost of mortgages is likely to persist for some time: interest rates are set to rise further over the coming 12 months or so.
The good news is that some if not all of the other factors that have been pushing the inflation rate up of late should prove transitory and some will unwind. This is almost certainly true of the exchange rate effect, which is already unwinding. It is also almost certainly true of the "potato effect": if history is any guide, large swings in the prices of potatoes and other fresh food produce in one direction are invariably followed by large swings in the other direction.
Taking everything into account, including energy prices, my judgment is that, looking beyond the next few months, which might see a bit more bad news, inflation is much more likely to decelerate than remain at or above its current rate.
If I were to suggest a figure to guide expectations of what the annual average rate might be over the 27-month term of the new pay agreement, it would be something not far removed from the average of the last 27 months. That turns out to be 2.5 per cent. That would suggest in turn that the new pay deal is worth about 2 per cent per annum in real terms. That's not a bad deal for workers on incremental scales who also have another round of benchmarking to look forward to.
• Jim O'Leary lectures in economics at the National University of Ireland, Maynooth. He can be contacted at jim.oleary@nuim.ie
