Public sector rates of pay no longer sustainable

OPINION: A strong case can be made for the possibility of wage cuts in the public sector being considered, argue Alan Barrett…

OPINION:A strong case can be made for the possibility of wage cuts in the public sector being considered, argue Alan Barrett, Ide Kearneyand Jean Goggin, the Economic and Social Research Institute economists who co-authored the ESRI commentary published today

THE FORECASTS contained in the Economic and Social Research Institute's (ESRI) latest quarterly economic commentary show clearly that the economy is currently experiencing severe difficulties and that these difficulties will persist well into next year and perhaps beyond.

The sources of the difficulties are well known. The global economy is experiencing a dramatic downturn and Ireland is being affected. Export markets are shrinking and both consumer and business sentiment are suffering. In addition, Ireland is also going through a major contraction in house building, the result of which is to make the downturn here much steeper than elsewhere.

The effects of the downturn are rapidly becoming very real, for example, in terms of job losses. The rate of increase in the Live Register is at historic highs, with over 100,000 people being added in the year ended November 2008. As the situation is both poor and deteriorating, the natural question that arises is what can be done. Unfortunately, the policy tools available to the Government to overcome the difficulties in the short run are very limited.

READ MORE

For example, while the recapitalisation of the banks with public money may be necessary for the long-term health of the economy, it may not lead to any immediate rebound in bank lending. In recessionary times, bank lending tends to be curtailed regardless of the financial health of the banks at the outset of the downturn. Almost by definition, a recession implies an increased risk of bankruptcies for businesses and households. Without perfect information on who are good risks and who are bad, banks will tend to be more conservative in general when lending. Hence, lending is likely to be constrained in 2009, even with recapitalisation.

The possible use of a fiscal stimulus has been proposed as another anti-recession policy tool. With the general Government deficit forecast by us to increase from 6.9 per cent of GDP in 2008 to 10.2 per cent in 2009, we cannot see the scope for this. For us, this movement in the public finances is a source of concern because it represents a possible constraint on our ability to emerge strongly from the current problems.

On the basis of our forecasts, the general Government debt will have risen from 24.8 per cent of GDP in 2007 to 47.5 per cent at the end of 2009. This debt level in itself is not a concern but the speed with which the debt is increasing is a big concern.

In order to ensure that mounting public debt does not act as a constraint on future growth, as it did in the 1980s, there is now an immediate need to start the multi-annual process of bringing the public finances back on to a sustainable path.

In this context, it now seems clear to us that it will be difficult for the Government to pay the 3.5 per cent due on September 1st, 2009, under the terms of Towards 2016. There is a need to reopen negotiations on partnership and for all sides to take account of the drastically changed circumstances facing the economy.

We believe that a strong case can be made for the possibility of wage cuts in the public sector being considered. With tax revenues plummeting, the State's ability to pay its public servants at existing rates may not be sustainable. If choices have to be made between reduced numbers, and hence levels of service, or lower rates of pay, the latter would surely be preferred by many. In addition, the speed with which the public finances are deteriorating is such that a pay-based approach might allow public sector savings to be realised more quickly, relative to an approach based on job reductions.

It should be stressed that a moderation in public sector pay on its own will not be sufficient to restore balance to the public finances. Expenditure cuts will still be needed. Ideally, these should be achieved through the elimination of waste and inefficiencies and through the cancellation of capital projects with low rates of return.

And while tax increases would not be desirable at this point in time, it is likely that such increases will be needed in the medium term. The ending of the property boom brought with it an erosion in elements of the tax base which will not return. In order to sustain desired levels of public spending, extra revenues will need to be found.

Ireland will only return to a path of growth when (a) a global upturn begins and (b) if Ireland is able to compete in world markets. Only at that point can we see consumer and business confidence lifting.

The international forecasts used in our commentary published today see a very modest upturn beginning in the middle of 2009, although with output remaining below trend into 2010. Our hope would be that wages, and other prices, adjust rapidly in Ireland so that our economy can participate successfully in the global upturn. This would imply a re-emergence of positive growth in 2010, although at a low level.

We remain concerned that a failure to bring order back to the public finances will act as a drag on growth. This could happen if the burden of interest payments rises, if an increasing debt leads consumers to expect future tax increases above what might otherwise be needed and if investors interpret mounting deficits as a negative signal for the quality of governance. These scenarios need to be avoided so that Ireland's lost decade of the 1980s is not repeated.

The ongoing importance of active labour market policy and competition policy should be stressed. ESRI research from the 1990s demonstrated very clearly how important it was to keep the unemployed close to the workplace, through training and employment programmes that were closely related to labour market needs.

And in the context of unemployment, one issue which will return to the national agenda soon is the relationship between wages and unemployment benefits and assistance. With wages likely to be depressed in the coming years, ongoing increases in welfare payments would result in an increase in replacement rates, with implications for incentives to move between welfare and work. This issue will need careful consideration when budget 2010 is being prepared and when a review of the national minimum wage is conducted.

Finally, efforts should continue at ensuring that competition policy is used to the fullest extent possible to remove any remaining barriers to entry in areas such as retailing. Competitiveness will be aided through such moves and this is a key requirement of policy at present.