Posted on Wednesday 8 February 2012 by Ulster Business

An honest wage

Mark Magill, senior economist at Oxford Economics, takes a closer look at the scale of wage imbalances that exist in Northern Ireland and the impact this could have on the wider economy in future.

The impact of globalisation on income inequality has received a lot of attention in recent years, particularly since the global financial crisis.

Indeed, many commentators point to large imbalances in the world economy and maintain a view that the past century of unequal global growth has contributed to an unfavourable income distribution.

The global wealth pyramid has a very wide base and a sharp point. The richest 1% of adults control 43% of the world’s assets; the wealthiest 10% have 83% while the bottom 50% have only 2%.

A recent cross country report of 22 ‘rich world economies’ by the OECD found that wage inequality had risen fastest in the UK over the previous three decades. This trend prompted the establishment of the High Pay Commission to scrutinise spiralling executive pay across the public and private sectors. The Commission has forecast that without action the top 0.1% of earners in the UK will see their share of national income increase from 5% today to 15% by 2030. To put that into context, a pay gap of this scale has not been seen since the Victorian era.

Wage distribution in Northern Ireland

In Northern Ireland considerable differences in wages also exist. The median wage in Northern Ireland is £23,185, while the top 10% of earners have a median wage of £44,601, 1.92 times what a typical worker in Northern Ireland earns.

The scale of this differential ranks 4th of the 12 UK Government Office Regions, only ranking behind London, the South East of England and the North West of England.

There are considerable differences in pay across occupations in Northern Ireland, with those employed in senior positions delivering frontline public services, public administration professionals and engineering professionals topping the occupational earnings rankings.

At the other end of the scale occupations such as waiters/waitresses and catering staff earn less than half of what an average job in the Northern Ireland labour market pays.

While the earnings debate in the UK is focused upon a pay gap between the corporate elite and the general public, the debate in Northern Ireland takes a somewhat different shape.

A lack of large multinational companies headquartered in Northern Ireland has not led to the formation of an elite section of society earning multiple times what the general public earn, as is the case in some other parts of the UK, particularly London. A combination of the lack of an established and vibrant private sector and a legacy of the past has contributed to the creation of an economy where many of the best paying jobs are within the public sector funded by the UK taxpayer.

The public private wage differential

In Northern Ireland private sector wages are the lowest of the UK regions (83% of the UK average), while the public sector wage is above the UK average and is the 3rd highest of the UK regions. The median public sector wage in Northern Ireland is 42% higher than the private sector median. The extent of this public-private gap is much higher than the UK where the public-private gap is just 17%. Indeed, the gap is the highest of any UK region.

The wage premium in the public sector exists across the earnings spectrum. For example, the lowest earners in the public sector earn 1.4 times more than the lowest group of earners in the private sector, and the highest earners in the public sector earn 1.2 times more than the highest group of earners in the private sector. The latter is an unusual structural characteristic shared by the northern regions in England.

However, it is important to mention that there are some valid reasons to explain why public sector wages are higher than the private sector.

Firstly, it has been well documented over the past decade that living standards (measured as Gross Value Added per head) in Northern Ireland have been stuck at approximately 80% of the UK average for much of the past decade. This is reflective of the fact that much of Northern Ireland’s private sector output is associated with relatively ‘low value added’ activity which in turn can only support low wage employment.

Northern Ireland has an extremely small knowledge economy, a low culture of export and only a tiny amount of research and development activity – all characteristics of economies that are shown internationally to support high wages. Private sector businesses can only afford to pay what their margins allow, and the current structure of Northern Ireland business against the backdrop of a global economic slowdown has not been conducive to significant wage increases in the private sector.

Secondly, many public sector wages are set nationally and Northern Ireland’s public sector wages thus reflect national conditions. They do not take into account lower living costs here, especially for the more affluent families. Where there is local bargaining, unionisation has helped to ensure that public sector workers secure the best possible pay settlement. Unionisation is very low in the private sector, and any unions that exist tend to have only a relatively small level of influence in comparison to their public sector counterparts.

Thirdly, the skill profile of public sector workers is higher than in the private sector with a larger proportion of degree holders and above that in the private sector. This has historically been the case and in recent years low skill jobs have tended to be contracted out, which has widened the difference in the skill profile and therefore the earnings differential.

While there are valid reasons for higher median salaries in the public sector, a 42% public sector pay premium is difficult to justify against a 17% premium in the UK – especially when it is considered that the gap would be wider if generous pension schemes offered to public servants are considered.

Public sector crowding out

In the short term there is an economic benefit to having high public sector pay as high paid positions are helping to prop up the economy during a period of low demand. However, over the longer term there are some important implications to consider.

The public sector wage premium makes it difficult for private sector employers to recruit the most talented people as most employers are unable to match the ‘above market rate’ pay scales in the public sector.

For example, a graduate economist entering a job within management consultancy will typically earn £16-19k as a starting salary. The current salary scale within the Northern Ireland Civil Service for an assistant economist is £27-31k. A talented individual would logically chose to work in the public sector on this basis, illustrating the difficulty some employers have in recruiting the brightest graduates and retaining them.

This crowding out essentially dilutes the quality of labour supply to the private sector, which has the potential to have a dampening effect on innovation and productivity within commerce over the longer term.

The current fiscal environment should also be considered within the context of this debate. Public expenditure per head in Northern Ireland has long been well ahead of other parts of the UK, and there is little doubt that Northern Ireland will have to share in the pain of the austerity measures being implemented across the UK. Maintaining such a large wage premium is costly, and directs public funds away from delivering frontline services. During each of the past three years public sector pay growth has outstripped the private sector, contributing to a widening gap and suggesting that the public sector has not been sharing in the burden of the recession.

Are we heading towards regional pay?

In his autumn statement the Chancellor included a commitment to review the case for regional pay in the public sector. George Osborne has written to the heads of pay review bodies giving them until July to draw up ways to ensure public sector wages equate more closely to the cost of living. He said it was not fair that private sector staff are paid far less than state workers in some parts of the country, and has vowed to iron out the differences.

In Northern Ireland, where the public sector still accounts for over one in three jobs, this is arguably more important than in any other region. The scale of lessening the gap is considerable. It would take approximately five years of pay freezes to reduce the differential in line with the current UK wage gap, and would take almost a decade of static pay in the public sector to bring public and private wages in line with each other.

An opportunity for first mover advantage

The timing therefore represents an opportunity to restructure how remuneration in the public sector is determined. There are a number of ways in which this could be achieved, notably by introducing more performance based incentives.

While there is significant scope for savings by more closely aligning public and private sector wages, it will only have the potential for a positive economic impact on the local economy if there is a mechanism to retain any savings made within Northern Ireland (as opposed to simply diverting funds towards the treasury). If a mechanism such as this were in place it would enable the saving to be directed towards areas proven to encourage economic development such as the capital budget or a specific fund for regeneration or skills development.

Any implementation of regional pay will be extremely challenging, particularly with rising living costs. However, the issue is firmly on the Government’s radar, and that alone should be enough of a catalyst to begin a debate that can lead to innovative solutions that ensure the local economy is ready for any changes in public wage setting mechanisms that may be decided by Westminster this year.

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