The big public pay squeeze

New pay settlements for thousands of senior civil servants, doctors, dentists and prison officers come into force today, with freezes or 1 per cent increases the new norm.

With all three political parties pledging harsh pay settlements for public sector staffs, the independent Incomes Data Services research body says that typical pay rises in the private sector are now drawing ahead of those in the public sector – a sharp reversal of the trend in recent years, which has also seen those at the top of the public pay tree catch up with top earners in private firms.

With the election only weeks away, public sector pay and pensions is proving to be a key battleground, and during their televised debate on Monday evening the three men vying to be the next Chancellor of the Exchequer promised only more pay restraint, especially for the better paid. The Conservatives have proposed a pay freeze for all those on more than £18,000; the Liberal Democrats want to see an £8 per week limit on pay rises; the Government has imposed a 1 per cent cap on the pay bill. Given that inflation is running at about 3 per cent, that implies a real terms cut for many staff who have been used to gradually improving their position, both in absolute terms and in relation the private sector.

During the recession many workers, especially in manufacturing, were faced with short-time working and low or non-existent pay rises. For much of the period inflation has been ahead of private pay settlements, and many families have only been able to cope with the squeeze because of cuts in interest rates from the Bank of England that have fed through to some mortgages, and specific measures such as the Government's cut in VAT. Those supports have either gone or will, by this time next year, be partially reversed, with more increases in national insurance on the way, though the extent of any rises depends on who wins the election.

But it is now public sector workers who are suffering the squeeze. Hundreds of thousands of local authorities workers have been laid off, according to a recent survey by The Independent, and the typical public sector pay settlement on the latest available data is running at 0.4 per cent; in the private sector it is between 1 and 2 per cent.

According to Incomes Data Services, there has been a "thaw" in private sector remuneration, with the proportion of settlements resulting in a freeze dropping from 37 per cent in the three months to January, to 34 per cent in the period to February. By contrast, IDS say that "new public sector awards for 2010 are significantly lower than those in the private sector".

From today, senior civil servants' pay has been frozen, as has that of better-paid doctors and dentists. Prison officers and junior doctors are 1 per cent better off; pay in the armed forces, the subject of much recent controversy, is up by 2 per cent. These are all real-terms cuts: retail price inflation is currently 3.7 per cent.

IDS say that they have recorded 19 pay settlements in the public sector this year, with all but one effective from today. The level of these awards is much lower than last year and, if increases under long-term agreements, for example, for NHS staff, are excluded, the typical pay settlement level is just 0.4 per cent.

Ken Mulkearn, the editor of IDS Pay Report, said that private sector settlements are strongly clustered around two points – zero and the 2 to 3 per cent range, with very few outside these parameters. "However the proportion of freezes looks like it may be falling, though there are clear differences between manufacturing and services. The likely influences here are a recovery in manufacturing output, with short-time working winding down, and higher inflation."

He added: "Looking further ahead, private sector awards look set to outpace those in the public sector, though much depends on the pace of economic recovery. We can already see the impact of the Government's pay squeeze on public sector settlements."

Even more striking than the disparity in pay awards has been the chances of being made redundant. Over the past year, some 46,000 jobs were created by the state; in the same period 527,000 jobs were lost in the private sector.

Over the last three months of 2009, employment in central government increased by 22,000, primarily because of growth in employment in the NHS – a 20,000 increase. Employment in the Civil Service was unchanged from the previous quarter at 532,000, but local government decreased by 2,000 and public corporations decreased by 13,000. Employment in the private sector decreased by 61,000 in the same period.

The latest figures from IDS are based on 94 pay settlements, covering 279,513 employees in total.

The pensions gap: Disparity between public and private sector grows

The next political battleground over rewards in the public sector is likely to be the generosity of public sector pensions. The respected, and politically independent, Institute for Fiscal Studies said yesterday that the disparity between public and private sector rewards has become even starker in recent years once pension arrangements are taken into account.

The IFS reports that on average the earnings of public sector workers grew by 2.3 per cent a year from 2001 to 2005, 0.8 percentage points a year faster than that of their private sector counterparts. However, including the changing value of employer-provided pensions widens this gap by one-third to 1.1 percentage points, with the total value of pay and pensions growing 2.4 per cent a year on average for public sector workers, against 1.3 per cent a year in the private sector.

While there was little change in either membership rates or accrual within public-service pensions, the private sector witnessed a continuation of the long-running decline in membership of private sector defined-benefit schemes. Instead, workers are offered money purchase schemes, where there is no guarantee of income in retirement. Most observers regard these as inferior, especially when employer contributions are measly.

Rowena Crawford, a research economist at the IFS, warned that public sector pay awards or pensions schemes could be cut if the gap between private and public sector pension plans continues to widen. "If so, the appropriate choice [between public sector pay or pension cuts] should depend on which of these options delivers relatively better value for the taxpayer in terms of the impact on recruitment and retention of public sector workers of suitable quality."

Recently the Government has negotiated lower accrual rates and benefits for some public pension schemes. But even if larger cuts were to be imposed, as all three parties suggest, the savings would not feed through to the public finances for many years.