Saturday, February 01, 2003
Negotiating a difficult pay round
Posted by David Smith at 08:57 PM
Category: David Smith' s magazine articles

One of the most encouraging features of Britain’s economy in the past few years has been that falling unemployment, now back under 1m on the claimant count measure, has not resulted in an acceleration in pay settlements.

Those of us with memories of dangerously destabilising wage-price spirals, an Achilles heel of the economy in the past, have to wonder each time we look at the data whether there has been a permanent shift in wage bargaining behaviour, or whether the danger is merely dormant. Average earnings growth, which never dropped below 7.5 per cent in the 1980s, even when inflation was low, is currently rising at just half that rate, 3.7 per cent.

In the past few years the labour market has thrown up benign wage outcomes against, it should be said, the predictions of many analysts. Not so long ago, economists used to think a drop in the unemployment rate below 6 or 7 per cent would result in a significant increase in pay pressures. Instead, the jobless rate spent last year a shade over 3 per cent but wage increases stayed low.

The CBI’s own figures, for example, showed manufacturing pay settlements at around 2.5 per cent and, if anything, decelerating as the year went on. Service sector settlements were higher, by a percentage point or so, but not by enough to raise serious worries.

So why should we worry about this year’s pay round? The reason, as the Bank of England has pointed out, is that several factors are coming into play this year that pose potential problems. Achieving the same kind of benign outcome as in recent years will take some doing.

There are three main threats. The first is the effect of a rapid expansion of public sector employment, the consequent risk of higher public sector pay settlements, and the worry that this will carry over to the private sector.

The second, probably uppermost in the minds of most firms, is the coming increase in National Insurance contributions. This could be, if we are not careful, a double whammy for business. The certain effect is the 1 per cent rise in employers’ contributions, which will cost business 3.9 billion in the first year.

The other potential effect comes from the 1 per cent rise in employee contributions, which will raise just over 3.5 billion for the chancellor but could also be an extra burden on firms’ costs, if employees expect to be compensated by higher pay.

The third problem comes from inflation itself. Part of the reason for the benign pay rounds of recent years has been that inflation has been low. For the best part of four years the Bank has done its job a little too well, and inflation has come in below the official 2.5 per cent target. That is no longer the case.

Inflation is above the target at time of writing and set to remain so for the first half of the year. As every pay negotiator knows, the current inflation rate is usually the starting point for talks.

So how bad is it going to be? Let us take the three factors in turn. Aggressive public sector recruitment is certainly in evidence. Most of the executive appointments sections, including in The Sunday Times, are now dominated by public sector positions, with a distinct shortage of private sector jobs. The same is true, although perhaps to a slightly lesser extent, at lower levels. The irony will not be lost on business that this expansion of public sector employment is made safer by the fact that private sector recruitment is at such a low ebb. Gordon Brown would call this good planning, but it is plainly just good luck.

Even so, public sector unions know that delivery of better services is vital to the government’s second term. They have also been pushing hard for better pay packages to compensate for, for example, high housing costs in the South East. Having said that, there is no sign that the government is abandoning its relatively tight rein on public sector pay settlements, and its tough line in the fire-fighters’ dispute has demonstrated that. Some slippage is occurring, and we can expect average earnings in the public sector to outstrip those in the private sector for a while, but there is no sense of an impending free-for-all.

The National Insurance increases are another matter. This year is a terrible time for them to be happening. One of the warnings the Bank made public in its latest Inflation Report was of a greater “pass-through into wages and prices of the increases in NI contributions”. Indeed, companies and their workers are left to choose between two evils. For manufacturers, in particular, the climate is likely to be so tough that compensating workers for the NI rises will have to be resisted, in which case it will be employees who suffer a squeeze. For firms in the more buoyant service sector, particularly those competing for employees with the public sector, there may be no option but to concede higher settlements. Either way, it is something business could have done without.

The risk from the third factor is, I think less. If pay negotiators are prepared to accept that the current period of above-target inflation is temporary, as it should be, and the rate will be back below 2.5 per cent in the second half of the year, there will be no case for ratcheting settlements higher.

So a difficult few months lie ahead. I suspect, in the end, we will not see a decisive break from the recent benign pattern of pay outcomes. This is because, I hope, common sense will prevail. But it is also because a long shadow of uncertainty continues to hang over the business outlook. The chancellor may get away with his NI increases in terms of their impact on wage inflation but only because the economy is likely to be weaker than he expected. The lesson must be that he should not try anything like it again.

From Business Voice, February 2003

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