Spending without productivity improvements won’t lead to better public services

Restoring the differentials in public and private sector pay to those which prevailed in 2010 without quid pro quo increases in productivity is simply stirring up trouble for the future, says Paul Ormerod

The decision by the government to stuff money into the bank accounts of the train drivers and junior doctors has been widely discussed. But the constant insistence by the doctors, and many others in the public sector, that they have in some ways suffered since the year 2010 has received much less attention.

The use of 2010 as the reference point is key. It may well seem an innocuous choice, probably selected because that was when the coalition government came to power.

But it is a very deliberate choice. That particular year represents the high water mark of overall public sector pay relative to that of the private sector.  No wonder that public sector unions are keen to restore the relativities of 2010.

In the first few years of the Blair government after his 1997 election victory the then Chancellor, Gordon Brown, stuck firmly to the spending plans of the previous Conservative government. But then he opened the taps.

Until the financial crisis of 2008, the economy grew strongly. Brown was lucky. Growth generated more and more receipts from taxation without having to put rates up. And the receipts financed increases in public spending.

Some of the higher spending translated into desirable outcomes. The Sure Start scheme, for example, championed by Brown, is widely credited as having had a positive impact on the children of low income families.

But not all of the extra spending delivered better public services.  A non-trivial amount went into boosting the private consumption of those employed in the public sector.

After Brown’s initial period of a self-denying ordinance after the 1997 election, by 2000 gross median annual earnings in the public sector were 10.1 per cent higher than in the private sector.  In 2010, the difference was 14.7 per cent.

By 2019, the year before the pandemic, the Conservatives had succeeded in reducing the differential to just 6.7 per cent.

An argument often used to justify the higher average pay in the public sector is that the workers in the public sector tend to have higher educational and skill levels.  

But this is an argument which brings back memories of the Soviet Union. What counted there was the value of the inputs rather than the value of the outputs. The leather used in shoe production mattered. The fact that all the shoes might be in just a single size, or only made to fit left feet, was of much less significance.

Outputs matter more than inputs

It is of course the value of output which is of much greater importance. The mark of success of an economy is the extent to which it can increase the difference in value between the inputs used in production and the value of the outputs which emerge from the process. In a word, productivity.

And it is becoming increasingly well known that, overall, the productivity record of the public sector is appalling.

There are genuine reasons why it is harder to increase productivity in many parts of the public sector compared to the private. But even so, the Office for National Statistics estimates that the average levels of productivity in the public sector are in fact marginally lower than they were in 1997, over 25 years ago.

Proposals to increase pay in the public sector without securing agreements to increase productivity in general make very little sense.

The exception is in those parts of the public sector where we know pay is too low because there is a high turnover in the workforce. This is a key feature which the admirable pay review bodies take into account when making their recommendations to government.

Restoring the differentials in public and private sector pay to those which prevailed in 2010 without quid pro quo increases in productivity is simply stirring up trouble for the future.

Paul Ormerod is an economist at Volterra Partners LLP, an Honorary Professor at the Alliance Business School at the University of Manchester and author of Against the Grain: Insights of an Economic Contrarian, published by the IEA in conjunction with City AM