Wage cuts: road to recovery or path to prolonged slump?

 

Budgetary planning appears to be moving inexorably towards public sector pay cuts. But are wages the problem? Two economists, DAVID CROUGHANof Ibec and PAUL SWEENEYof Ictu, argue both sides of the issue

DAVID CROUGHAN

THE DECEMBER budget will determine whether Ireland can take control of its finances and chart a viable path to recovery. Despite some early signs of economic stabilisation, the economy remains in a state of serious distress. There is general agreement that very major and difficult surgery is required if we are to return to prosperity.

The issue is, how?

There are two linked but separate criteria for success – fairness and effectiveness. Only a demonstrably fair approach is likely to have the public support that will turn the country around; an ineffective response is unfair to everyone. Output and employment are falling back to 2004 levels. We have little choice now but to reverse our competitive decline through wage restraint and improved productivity. The more optimistic forecasts that are beginning to appear are indeed predicated on such a rapid restoration of our ability to compete effectively.

The central problem has been the decline in competitiveness caused by the squeezing out of the traded goods and services sector by an overheated construction industry, which bid up wage rates and other costs. We are now 15 per cent less competitive in relation to our trading partners than we were in 2000. This position needs urgent redress. In a single currency, a loss of competitiveness cannot be countered by devaluation; costs, including labour costs, must fall.

If this doesn’t happen, Irish companies will fail and unemployment will increase. This is in nobody’s interest.

There is a clear choice between jobs and pay. There have been enough job losses. It is grossly unfair and obviously ineffective to allow Irish pay rates to put more people out of work. That is why pay rises before 2011 are unrealistic.

We must also tackle the problem of the public finances. The reality is that tax revenue, which is solely reliant on our ability to successfully trade goods and services at home and abroad, is insufficient to pay for current public expenditure levels.

Despite April’s Supplementary Budget, which outlined the corrective action needed to reduce the borrowing requirement to less than 11 per cent of GDP, the most recent exchequer returns point to the deficit rising to an unsustainable 12 per cent. This will result in an even higher cost of servicing the debt, which is already set to rise from €3.9 billion in 2008 to €11.2 billion by 2013. Attempts to improve the situation by excessive tax increases will only make matters worse by stifling growth and adding even more to the burden of those trying to compete in a competitive world.

Both the private and public sectors are in a similar position: the private sector must contain costs to survive and grow businesses and employment; the public sector must contain costs within the limits of tax revenue to avoid crippling taxation or unsustainably high debt levels. The burden of adjustment must therefore be borne by both public and private sectors.

Ibec has carried out extensive survey work this year on a sample of over 500 companies employing close to 90,000 employees. On average the total pay bill in private sector companies has decreased by 11 per cent in 2009. Of course, this has not been uniform across all sectors; those companies facing the most difficulties cut the most. Of the 56 per cent of companies that had reduced their pay bill, the average reduction was 21 per cent.

Private companies have achieved these pay reductions in a variety of ways. Aside from wage reductions, some employees have accepted pay reductions by forfeiting shift premiums; others have worked unpaid overtime; others have agreed to taking one or two days a month of unpaid leave. This has not only reduced pay levels but has also increased productivity.

A large number of companies indicated further pay reductions were needed in 2010. While not all private sector employees have experienced pay cuts, those working in businesses most affected by the recession have accepted substantial pay reductions of the order of 12 per cent to protect their jobs.

The public sector has also effectively reduced pay by the imposition of the pension levy. However, when we look closer we see that the failure to stop incremental pay increases or increases through grade changes has undermined the impact. To be fair and effective, more reduction is needed.

The Central Statistics Office has found that, adjusting for education, experience and hours worked, average public sector pay in 2007 was 19.1 per cent higher than in the private sector. The recent report by the Economic and Social Research Institute, The Public-Private Sector Pay Gap in Ireland, based on 2006 data, found the public sector pay premium was 26 per cent. This report used techniques which take account of job content, resulting in a better comparison. The study also takes no account of superior public sector pensions.

Recognition of these facts must find its way into the management of public sector wages. It is far better to cut the cost of public sector provision through pay and other cost reductions, than to reduce frontline services and jobs.

Only a short time ago, Ireland was a thriving economy with continuing bright prospects. Nothing fundamental or irreparable has happened to prevent Ireland from lifting itself back to the confident position it held at the start of this decade. We must all recognise that serious mistakes were made, and learn from them. We lost ground, we became heavily indebted, and the economy became seriously unbalanced. Parts of the construction sector and the financial sector acted recklessly and compounded these problems.

Now we need to agree a way to restore the competitiveness that earned us the high living standards and full employment we enjoyed until recently. Industrial disruption would simply put more jobs at risk and delay recovery. That would be neither fair nor effective.


David Croughan is chief economist at Ibec, the Irish Business and Employers Confederation

PAUL SWEENEY:

ECONOMY-WIDE CUTS in wages will reduce sales, throw people out of jobs and close firms. It will be deflationary and will delay the recovery. It will reduce tax revenue to the Government and require increased public spending on job supports.

Most importantly, it will not work. Just as inflation is largely determined externally, so too wage cuts will not necessarily translate into reduced prices. And why should the focus be solely on employees, who did nothing to bring down the Irish economy?

There is a certain irony in the attack on trade unions by Prof Patrick Honohan in his first speech as the new governor of the Central Bank, where he characterised us as having a “fetish” against nominal wage cuts. Competitiveness is far more complex than mere wage rates and movements.

It is Honohan who has the fetish – asserting that wages are the driver of competitiveness. Similarly, the director of the Economic and Social Research Institute says “our relative unit wage costs must fall, through a combination of lower wages and higher productivity”. That is far too simplistic an argument.

Today, we have a much better understanding of what makes a country competitive than in the past. We even have a very active National Competitiveness Council – an employers’ initiative, which focuses on all aspects of this complex issue. Its reports, respected internationally, see wage rates in their true perspective as one, albeit small, part in national competitiveness.

There are a number of facts around the issue of wages which are helpful to an understanding of Ireland’s position, and of where Ictu is coming from.

First, Irish wages and salaries have risen faster than competitor countries in the past few years as we moved closer to other EU countries during the boom.

Secondly, earnings, wages and salaries in the private sector have not fallen in recent times. They have risen, the latest data show.

Thirdly, and this is rarely acknowledged by the wage-cuts chorus, Irish earnings, wage rates and salaries are still below those in most competitor countries, according to published comparative data. More importantly, the total cost of employing a worker in Ireland is well below that of most competitor countries (22nd down a long list of the rich countries according to the Organisation for Economic Co-operation and Development in 2007). I acknowledge that the rise in the value of the euro has reduced our position since then.

It is generally not known that Ireland’s productivity remains one of the highest in the world, in spite of recent slow growth. The last OECD survey put us at second highest in the world after Norway and ahead of the US in 2006. However, our position is boosted by transfer pricing by multinationals companies (MNCs). But even adjusting for this, we are still one of the top performers.

There is always room for economy-wide productivity improvements, including in the public service. It is an area which should be addressed as part of an agreed recovery programme.

Inflation has fallen, but most of the fall is due to interest rate falls. Thus, the majority, who do not have mortgages, are not benefiting much from the fall in prices. Further, Irish workers face the second highest price levels in the world, after Denmark. Goods are 14 per cent above the EU 15 average, and services a whopping 23 per cent higher. Wages played a part in these high prices, but so did excessive profits, high professional fees, and especially the shift in taxes from incomes and profits to spending taxes.

I made this point in this newspaper back in 2006 (February 16th). That was the time for tax reform, as the economy was booming and there were great surpluses in taxes. I called on government to cut spending taxes. Not one economist supported this call, as few were interested in the high price levels in Ireland back then.

Where total earnings are being adjusted downwards in individual firms in the private sector, it is mainly through reduced hours, new ways of working, reduced bonuses, etc. Yet unions are agreeing to reductions in the basic wage rate where the firms or jobs are at serious risk. However, as stated above, private sector earnings are not falling nationally. And Irish exports are doing well compared to those of many countries, which is instructive in this debate on competitiveness.

Cuts in basic wages, for low and average wage workers, are very harsh. They are seen as a last resort, and decent employers also think this. It is interesting too that Ibec has called for a pay freeze until 2010, but unlike the academics, it has not called for cuts in nominal wages.

Public sector pay was cut by 6.8 per cent on average in 2009, but this will not show up in the CSO data published later next week, as it is a “pension levy” and technically not a reduction in earnings! Total aggregate earnings in the economy are already declining because there are about 200,000 fewer at work now than at peak employment in 2007. This is reducing domestic demand, and further wage cuts would exacerbate the deflationary impact.

To argue for economy-wide cuts in wages in this environment would make things far worse. It is also unrealistic. It won’t work – the transmission system of wage cuts into low price levels is not operational, except perhaps in some econometric model.

Finally, it is rich that highly paid individuals call for cuts in pay when two-thirds of employees earn under €42,000 a year. They cannot afford more income reductions. There is fierce anger in the workplaces of Ireland.

Regular employees did not cause this crisis. They will play their part in fixing it, with higher taxes to subsidise the failed, private sector banks. To expect them to also take deep pay cuts on top of that, in the very faint hope of reducing prices, is simply not on. Economy-wide pay cuts would also make things much worse.


Paul Sweeney is economic adviser to Ictu, the Irish Congress of Trade Unions

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