Sunday, May 07, 2023
Pay's the issue, but don't forget public sector pensions
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

There is as yet no end to the wave of industrial disputes mainly affecting the public sector and former nationalised industries such as the railways. In the NHS, the government has yet to settle its dispute with the Royal College of Nursing and junior doctors represented by the British Medical Association, though it has just pushed through a 5 per cent pay rise for most employees to try to force the issue. Teachers were on strike during last week and the unions are talking of co-ordinated action in the autumn.

Rail unions intend further walkouts, some of which are due to coincide with the Eurovision song contest in Liverpool next weekend and the FA Cup Final next month.

One milestone has been passed in these strikes. More than three million working days were lost because of industrial disputes between June last year, when the Office for National Statistics (ONS) resumed publication of the data, and February this year, the latest figures. To put that in perspective, it is roughly 12 times the annual average total for days lost over the 2015-19 period. A problem that we thought had been solved has returned.

Another development, which has happened without fanfare, is that the gap between private and public sector pay growth has narrowed significantly. A year ago, the annual growth in private sector pay was 7.8 per cent, well ahead of the public sector’s 1.4 per cent. Now, while the private sector is still ahead, the difference is much less marked, with annual increases of 6.1 per cent versus 5.3 per cent over the latest three months. Both, of course, are well below current double-figure inflation.

Mention of public sector pay rises, and the wave of disputes, brings me to a point which is often raised with me. This is the fact that public sector workers benefit from much more generous pensions than is typically the case for their private sector counterparts.

Most public sector workers, more than 80 per cent, are in defined benefit pension schemes, traditionally final salary schemes, which provide a pension as a proportion of salary on retirement. In contrast, defined benefit schemes are now rare in the private sector, covering just 7 per cent of workers.

According to the Institute for Fiscal Studies nearly half, 47 per cent, of public sector workers had an employer contribution to their pensions of more than 20 per cent in 2021, compared with just 2 per cent of private sector workers. Every increase in pensionable salary means an increase in those contributions, which is one reason that in some of the disputes, the government has been offering one-off, non-pensionable cost of living payments.

Once these more generous pension arrangements are considered, and adjustments are made for other factors such as education and skill, public sector workers earn more. The Office for National Statistics estimated that in 2019 the public sector premium – the greater rewards enjoyed by public sector workers including pension contributions – averaged 7 per cent. A more recent estimate by the IFS calculated that public sector workers earn 6 per cent more in total.

Why has the government resisted public sector pay demands? It insists that if it gave in the impact would be inflationary, though the evidence for that is gossamer thin. But it might also be worried about the impact of higher pay on unfunded public sector pension liabilities.

These liabilities are large. In fact, according to the whole of government accounts (WGA), produced by the Treasury annually, they are the government’s single biggest liability, amounting to just under £2.2 trillion in 2019-20, the latest year for which figures are available. Statistics for 2020-21 will be published this summer.

That £2.2 trillion is bigger than the national debt was in 2019-20, before its pandemic surge, and represented a huge chunk of total government liabilities of almost £5 trillion. Some 82 per cent of the public sector pension liability comes from just four schemes, the National Health Service Pension Scheme, the Teachers’ Pension Scheme (England & Wales), Cabinet Office Civil Superannuation, and the Armed Forces Pension Scheme.

What to do about it? These liabilities, while large, are not going to bankrupt the country – the Office for Budget Responsibility (OBR) estimates that in the long run, government spending on public sector pensions will account for just under 2 per cent of gross domestic product, with a trend that is slightly down, thanks to recent reforms.

But there is something unhealthy about the huge differential building up between public and private sector pension arrangements, because of the collapse of private final salary schemes in recent decades. Not only that but, as many public sector workers have discovered over the past 2-3 years, you cannot live on future pension promises alone. More generous employer contributions and a better pension are things that will be of benefit later, not now. They do not help with the cost-of-living squeeze, which is why we have seen so many strikes.

Changing pension arrangements in politically toxic, as President Emmanuel Macron has discovered in France. Some would say private pension arrangements should be improved, rather than the other way round. In the absence of that, there looks to be a good case for public sector pension reform. The IFS, in last year’s green budget, had one such suggestion.

“There is a strong case for rebalancing public sector remuneration away from pensions and towards pay,” it said. “A far greater share of overall public sector remuneration is deferred, in the form of both employer and employee pension contributions, compared with the private sector, and this difference has been increasing over time. That means for a given level of remuneration, take-home pay is lower in the public sector.”

An initial change, which would be painless, would be to reduce the contributions made by public sector workers themselves, immediately increasing take-home pay, in return for less generous pension entitlements. Employer contributions could subsequently be reduced as well.

But, while the OBR noted in a recent report that there have been 16 separate and significant changes affecting public sector pensions since 2010, including a shift from RPI (retail prices index) to CPI, the consumer prices index for uprating, and a shift towards career average rather than final salary schemes, this may be a battle no government wants to fight. One recent change in the March budget, the abolition of the lifetime allowance for pensions, ostensibly to prevent NHS consultants from retiring early, will add to the cost of public sector pensions.

Further reform may be needed because of another potential change. This, the discount rate applied to public sector schemes, is a key determinant of how much employers will have to contribute to meet pension obligations. The rate is ripe for a reduction, in line with more downbeat long-term expectations for economic growth. And, while the details are too technical to go into here, a significant reduction in the discount rate would have the effect of making pensions even more of a cuckoo in the public sector nest.