The coalition government is concerned about public sector pay and has instigated a review chaired by Will Hutton. He will be looking at the level of pay across sectors and within the public sector. However, one issue on which there have been fewer pronouncements to date is the regional variation in pay within the public sector.
Pay in the public sector for doctors, teachers, nurses, the armed forces and other public sector workers is set by the pay review bodies. They review the state of the labour market and recommend a level of pay to the government and the unions each year. Public sector unions often stress fairness in their wage negotiations: the commonly articulated view is that a teacher in an inner city in Newcastle does the same job as one in inner London and should therefore be paid the same wage.
Perhaps as a result of this argument the review bodies basically set one wage for all the workers they cover, regardless of where they are located in the country. There are extra increments for those located in the South East and London, but these tend to be small. The result is that wages in the public sector tend to be much ‘flatter’ across geographical space than private sector wages.
As an example, the difference in the pay of a nurse located in the North East and London is around 15%. However, the difference for a private sector employee with similar skills to a nurse is in the order of 40%.
Such large gaps are likely to cause recruitment and retention problems for public sector employers in the South East as their workers live in a high-cost area and as a result will be offered higher wages in the private sector. Shortages of nurses and teachers in the South East have been an ongoing and well-documented problem. But is it likely that these recruitment and retention problems also have a knock-on effect on the productivity of public sector services in high-cost areas?
Shortages of workers, high turnover rates and, perhaps, low levels of morale as a consequence are likely to cause production problems. CMPO research on nurses’ pay has confirmed this intuition: centralised regulation of nurses’ pay caused extra deaths per year amongst patients admitted to hospital following a heart attack. They also calculated that wage regulation didn’t even save the government much in direct wage costs as the benefit of lower wages bills in the South East was offset by higher pay in the North of the country so the wage savings were small.
The reason for the small wage savings were that the pay review body gets the level of wages ‘right’ on average – what they get wrong is the extent of variation across different parts of the country. These seems very plausible: the review body takes evidence from a wide variety of sources and probably therefore sets the average level correctly, but in responding to union (and perhaps also public) pressure for equality in the public sector, gives insufficient weight to regional variation.
It is likely that public sector pay regulation affects the output of teachers, policeman and other public sector workers in a similar way, though this is still to be confirmed.
This all suggests that in addition to examining the level of public sector pay, Hutton should be equally concerned with the variation in pay across regions. One solution might be to deregulate pay altogether and let each employer negotiate with their local workers.
However, this also has costs. First, and most obviously, such wage negotiations are costly for both employers and workers in terms of time and the need for each employer to employ HR personnel skilled in wage negotiation. But second, in labour markets in which there is a shortage of workers, negotiations between single employers and their workers may simply drive up the price of labour for all local employers as employers seek to outbid each other to attract staff.
This means that no single school or hospital will wish to engage in such negotiation, because any advantage they initially get from offering a higher wage, will be quickly eroded as other local employers follow suit. Whether for the first and/or the second reason, it is the case that hospitals in England, when given the freedom to negotiate local wages in various NHS reforms have generally not done so.
The solution might be therefore to retain the pay review bodies but to ensure that they allow for much larger wage differentials across the country. In so doing, they will have to resist calls from the unions – and possibly the public – for equity in pay setting. But far from being fair, such equity penalises public sector workers in high-cost areas, over-rewards those in low-cost areas and probably harms the users of the services these workers provide.
Carol Propper is professor of the economics of public policy at Bristol University’s Centre for Market and Public Organisation. This post first appeared on the CMPO blog
