Stephen Kinsella: Whole economy will feel pinch of public sector cuts
IMAGINE a small island. Three people live on this island. Anne, Barry and Cliona. Anne makes jam from her berry bushes and Barry makes bread from his cornfield. But they hate each other. They hire Cliona as a policewoman to keep the peace between them. They pay Cliona in jam and berries, which she likes, and which she trades with both Anne and Barry, who won't trade with one another, buying and selling to make everyone happier, safer, and better off. All is well.
One day, there is a cold snap. Half the berries die, and a third of the cornfield becomes useless. All of a sudden things are not looking so good for Cliona. She will have to take a cut to her payment of jam and bread, as these are hard times. But this will harm Anne and Barry as well. Cliona will not have the jam and bread to exchange with them, and so they will lose out.
Worse still, if Cliona decides not to do her job at all for a while, either because she's too hungry or too annoyed at her reduced pay, things could get ugly for Anne and Barry, who depend on her a bit like plumbing: they don't notice she's there until she stops working.
So what's the solution? The solution is for Anne and Barry to explain to Cliona that they simply can't keep paying her as she was being paid, but they will reduce her payments over, say, a few months. That way she can get used to the reduced pay, or decide if she wants to get a boat to another island.
I think this childish story gets to the heart of the debate on public sector pay. The simple fact is that Ireland can't afford the level of public services it now pays for, given our budget deficit and our projected rate of economic growth. This debate is fraught with emotion, some of it conflicting.
We must remember the objective: in order to reduce the difference between what the Government spends, and what it earns, we have to reduce the total wage bill, which is the sum of wages times the number of people being paid that wage. But this reduction must take place with the minimum of disruption to vital state services.
The Government's stated objective is to reduce the bill by 20pc over a seven-year period, and reduce the numbers from 320,000 in 2008 to 282,500 in 2015.
The largest cost within many areas of the public service is the pay bill. There are a few ways to reduce the total pay bill. One: Reduce pay across the board. Croke Park forbids this. Two: Increase taxes on incumbent workers. The previous government did, now the rate of tax on the last euro earned by a public sector worker is over 62pc, meaning they will only take home 38 cents from that euro. Three: Remove workers, which is happening naturally through retirement. Four: Hire new workers on lower salaries, hoping the reduction in size and the cost of new people will adjust the total wage bill down fast enough to make a difference in the bill.
In a 'Sunday Independent' article, economist Colm McCarthy has called for a new benchmarking exercise, to bring Ireland's public sector in line with international norms. This benchmarking process could begin immediately, and take effect once Croke Park has run its course. The Government should not unilaterally change the terms of its agreement with its employees. The benchmarking exercise should be scoped beforehand, because it may not work out as expected.
Remember the objective is to reduce the total pay bill. The benchmarking exercise would most likely increase some pay grades. If those pay grades made up some of the lower echelons of the public service, then the total bill might actually rise. When it comes to wage decreases for incumbents, while no one will be particularly upset if a professor on €140,000 takes a pay cut, you can expect those on lower pay grades to be extremely upset at the losses they will suffer as a result of benchmarking, with the attendant industrial action.
This is not a reason to stop the exercise. But a private scoping of the potential costs and benefits would be very advisable.
The authorities must also be aware that at the level of the economy, my spending is your income. If you cut my income, you cut my spending, and if I don't buy your products, I've cut your income, exactly as Anne and Barry found out.
In 2010, the ESRI estimated that for every €1bn in public sector cuts, consumer spending falls by approximately €750m. Domestic demand is now at 2003 levels. Any further drops in spending will cause an increase in unemployment and further hardship for the private sector.
Our household debt levels are some of the highest in the world, so large drops in public sector pay might well lead to a spate of defaults in the banks that the taxpayer now owns.
Anne and Barry have it easy. The Government's problem is much more complex.
Stephen Kinsella is a Lecturer in Economics at University of Limerick