A new approach to public sector pay vital for recovery


ANALYSIS:In its fiscal strategy for the post-troika medium term, the Government should rethink public sector salaries

This is set to be a pivotal year for the Government’s economic strategy. At the same time that it seeks to run an efficient and successful EU presidency, it must devote considerable energy to addressing both short-term and medium-term challenges in supporting economic recovery and the restoration of sustainability to the public finances.

In the short term, a basic challenge is to fully implement the measures set out in the 2013 budget. Around the world, implementation drift is a common factor behind the failure of recovery programmes, so the successful execution of the announced measures cannot be taken for granted.

In addition to the property tax regime, a key task is to secure the public sector expenditure savings and productivity gains that the Government believes can be achieved under the Croke Park agreement.

Moving beyond budgetary issues, the restructuring of the banking system remains a fundamental ongoing task for the Government.

In this regard, 2013 is a critical year in relation to the necessary resolution of troubled household debts in the context of new personal insolvency legislation. At the international level, the Government’s financial exposure to the banking system should be ameliorated by a re-engineering of the promissory notes and further progress can be envisaged on preparing the ground for the future disposal of the State’s equity stakes in the banks, whether to the European Stability Mechanism or private investors.

As listed in the memorandum of understanding with the EU-International Monetary Fund-European Central Bank troika, the list of short-term tasks for 2013 also includes water services reform, labour market reform and greater progress on the sale of State assets. More broadly, the Government has to continue rebuilding Ireland’s reputation as an attractive hub for international business, while supporting the growth of sustainable indigenous enterprises (in both the export and domestic sectors).

What makes 2013 a pivotal year is that, in parallel to accomplishing these myriad short-term objectives, the Government must also develop and communicate a credible medium-term fiscal strategy that will shape policy decisions in the post-troika era. The spelling out of an explicit medium-term strategy is essential for several reasons.

First, the Government will only be able to raise the large amounts of medium-term funding it requires from the markets (to fund the projected deficits from 2014 onwards and refinance the debt issues that will mature in the coming years) if there is clarity about how it intends to deliver the challenging fiscal targets required to gradually reduce public debt.

The progressive reduction of public debt (relative to gross domestic product) is desirable in view of the risks attached to a persistently high stock of debt, while it is also mandated under the fiscal treaty.

Second, the planned end of the troika funding programme means that the Government will have to take on a stronger leadership role in articulating and justifying the annual targets for the fiscal balance and mix of spending and taxation decisions in its medium-term strategy.

Put differently, the implication of restored economic sovereignty is that the Government must take the lead in setting out a fiscal programme that is both convincing to the markets and politically acceptable to the domestic electorate. Of course, the fiscal programme must also meet the minimal fiscal targets for 2014 and 2015 set out in the troika agreement and satisfy the new European-level appraisal system but these are consistent with a considerable range of fiscal strategies, so that domestic leadership remains paramount.

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.

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