The Freeze That Never Was

We need a new freezer

Back in his first budget in 2010, George Osborne imposed a two-year public sector pay freeze. It supposedly applied to all staff except the low paid, who were to get a flat £250 annual increase.

Unfortunately the freeze failed, as can be seen from the path of average public sector earnings since then:

Moreover, while the official ONS earnings stats show a 5% increase, calculations based on dividing the total pay bill by the number of employees suggest the true pay increase may well have been closer to 10%.

The pay freeze was a key element in George's attempt to curtail spending, so this is a serious failure. With a starting pay bill of around £170bn, a 5% overshoot is getting on for £10bn pa, and a 10% overshoot closer to £20bn. Annually.

So what went wrong?

Well, some of it - maybe one percent - is explained by the decision to exempt lower paid employees. Some may be explained by changes in the composition of the workforce. But most of the overshoot almost certainly reflects the operation of our old friend the incremental scale.

Virtually unknown in the private sector, this is the long-established practice of giving public employees guaranteed annual pay increases simply for serving another year. So for example, a newly qualified teacher generally starts on a salary of £21,588 (outside London). But she is starting at the foot of an incremental scale which then carries her up to £31,552 within 5 years - an almost 50% increase which is awarded irrespective of fiscal restraint or a Chancellor's freeze.

Yes, of course, experience does generally make employees more valuable, and over time we'd expect to see that reflected in pay. But in most of the private sector, increases are never automatic, and in tough times for the business a pay freeze generally means just that - a freeze for everyone, irrespective of their additional experience and overall merit. The viability of the business must come first, with the understanding that individual injustices can always be righted once the crisis is past.

And remember that this non-freeze comes on top of public sector pay that is already excessive against private sector equivalents. According to the ONS, on a like-for-like basis public sector pay rates currently exceed private sector by around 7%. The Institute for Fiscal Studies comes up with a similar 8% figure.

And on top of that, 80% of public sector employees still enjoy index-linked final salary pensions that are simply not available to most private sector employees: indeed, only around 10% of private sector workers now have any final salary pension.

How much is that worth? A lot: previous estimates suggest that higher average employer pension contributions in the public sector boost total rewards by about 10%. And in addition - even after recent reforms - public sector pension contributions are insufficient to fund the projected final cost of the pensions themselves. The difference will have to be made up by taxpayers, which adds further to overall rewards in the public sector.

In the BOM book (chapter 2) we present estimates suggesting the overall overpayment - taking account of both the pay premium and the pensions benefit - is of the order of 30-40%. In money terms that's somewhere in excess of £50bn pa, a sum that would go a long way towards cutting the deficit.

With such a big annual overpayment, the failure of George's freeze is worrying. In fairness, he clearly recognises the problem, and has at least attempted to tackle it - both through pay and action to reform pensions. But he hasn't done enough. And replacing his freeze with a 1% future cap was most unwise.

We will return to this.