Last week’s strikes by the various public sector unions have brought an old bug bear back to the front line: the gap between public and private sector pay. Unions (and their members) are angry about the Government’s plans to change the current terms and conditions of their pensions – in particular, to ramp up the contributions that some public sector workers pay for their pensions, and to shift to a career average salary rather than a current final salary arrangement. Some public workers are also upset about the fact they will be asked to work for longer, in line with the rises in retirement ages that will be phased in over the coming years.
In principle, your pension entitlement forms part of your total compensation from your employer – so, in a fair market, more generous pension terms ought to be offset by less pay now. In essence, people with more generous pensions are deferring more of their income to later on in life, rather than taking it at the point at which they earn it. The Government has pointed out that the existing public sector pension schemes are rather generous in comparison with private sector schemes. In particular, there are almost no ‘final salary’ pension schemes still out there in the private sector, and indeed few ‘defined benefit’ schemes at all (final salary being a particularly type of defined-benefit scheme). The shift from final salary to average salary pension would be particularly painful for young employees just starting out, as wages tend to rise most quickly up until your late 40s or early 50s in the public sector.
After that, switching from average to final salary doesn’t make as much difference. One key point in the proposals is that the pension entitlements that workers have accrued so far won’t be affected. So, if you are a 50-year-old senior mandarin earning around Â£100K, all your past entitlements will still be there at your current salary of Â£100K. Over the next fifteen years, the extra pension you accrue will be based on an average that will be somewhere between your current salary (Â£100K) and what you end up with (maybe Â£115K). For a new civil servant starting out on Â£25K, however, the picture is very different. While the salaries in the above example are very different, the key discrepancy is not so much salary as age. Even poorly-paid public sector workers in their 50s will not suffer that much – relative to what would have been – from the shift between final and average salaries.
The issue of contribution rates is a bit more contentious. Most private sector employees have to pay significant amounts of their own cash into their pension schemes, alongside their employers. But teachers and other workers are unhappy that the Government now thinks that they should pay more – on average, contributions will rise by 3.2 percentage points by 2014, a sizeable increase. (The poorest-paid will be protected from the worst of the increases.) The main argument here is that public sector pensions are not self-funded at the moment: they are subsidised by the taxpayer. Over the past decade, the gap between what public sector pensions pay out and what is put in has been rising – and although the Government expects it to fall under its proposals (at least as a share of GDP), that is mainly because the relative size of the public sector workforce is expected to shrink. At the end of the day, that’s just an assumption.
As an economist, I think employers’ pension schemes should generally be self-funding. Most private sector workers face not only this but defined contribution schemes as well – where they bear the risk associated with their pension investments, rather than their employer. There is no question of public sector workers doing that any time soon.
There is considerable anger, of course, that these changes are being forced through while the Government is trying to cut the deficit. But the simple fact is that, even without the banking crisis and the recession, public sector pensions would still have had to be dealt with sooner or later. It is unsustainable for a scheme to pay out more than it gets in every year. While bankers have a lot to answer for, blaming them for the underlying position of public sector pensions is wrong – even in 2006, it was clear that the schemes were unsustainable. The politicians just didn’t have the stomach to deal decisively with the underlying issues at the time.
The strikers are clearly counting on public sympathy for their cause. But they may find that sympathy in short supply. For all the claims and counter-claims, the definitive last word on public vs private pay has to come from the ONS, which has far more data than anybody else. According to research published last Autumn, total compensation for full-time employees is higher in the public sector – in no small part due to the large number of private employees who aren’t in a pension scheme at all. When we limit the analysis to those people with pensions (ie exclude a significant chunk of private sector workers), then total reward is a bit higher, on average, in the private sector. But this result, in turn, is skewed by a few people right at the top of the income chain – those private sector employees receiving hundreds of thousands or even millions of pounds. Private sector pay is far more uneven than in the public sector. Median total reward in the private sector was Â£479 per week in 2009 – compared with Â£615 in the public sector. And even at the 75th percentile – three-quarters of the way up the pay distribution, getting into the richer people in the country – private sector rewards were Â£718, compared with Â£829 in the public sector.
The bottom line is that, excluding the privileged few who earn megabucks, the public sector tends to pay more than the private. It also, until very recently, offered significantly higher job security. Given that private sector pensions have decreased dramatically over the past couple of decades, and many private employees still with jobs saw pay cuts or event freezes during the downturn, the unions may find themselves out on their own all too quickly.