Let's Remind Ourselves that Downsizing the Public Sector is Economically Daft

With negotiations over an extension of the Croke Park Agreement starting today, it is helpful to remind ourselves how daft it is to downsize the public sector payroll in the hopes it will reduce the deficit. 

There are two ways to downsize the public sector payroll:  cut public sector employment and/or cut public sector pay.  Since the crisis began, we have been doing both.  Public sector pay has been cut twice through the pension levy and the wage cuts of Budget 2010.  Public sector employment has been cut by approximately 29,700 since late 2008, or 9.3 percent. 

Yet, the Government finds that it must cut more than it had already planned.   It needs €1 billion more in austerity measures to achieve their targets.  It’s like running in quicksand – cut, sink, cut some more.

Yet, downsizing the public sector produces little benefit in stabilising public finances.  Why?  Because it is so darned deflationary – it bleeds the economy of employment, consumer spending and growth.  When you factor in the economic consequences of the cuts, you find the Exchequer hasn’t saved as much as it hoped.

Let’s look at the estimates from the ESRI.

Public Sector Employment

Even using common sense, without the aid of calculators or models, cutting jobs in a jobs recession is not a very good idea.  The ESRI’s model confirms this.  They took the example of ‘saving’ €1 billion by cutting public sector employment.  Because this is a model, they assumed the cut would happen in one year (but there would be little difference if this was spread out over years).  So what would be the impact by 2015?

• Impact on domestic growth:  ‘Saving’ €1 billion would reduce GNP by €1.85 billion, or 1.3 percent.  This is the most deflationary of the six budgetary cuts/taxes that the ESRI estimated. 

• Impact on employment:    There would be 20,000 job losses.  In the last budget the Government was estimating that employment would grow by 43,400 between 2012 and 2015.  However, if it seeks ‘savings’ through public sector job losses, employment growth would be reduced to 23,400.  Unemployment would rise from 13.1 percent to 13.8 percent in 2015 – and that’s only if there is increased emigration.

So growth and employment is cut, with a rise in unemployment.  Consume spending would fall by 1.2 percent (or approximately €1.13 billion) in 2015, putting more pressure on domestic businesses.  What would be the impact on the deficit?

A €1 billion ‘savings’ would only reduce the budget by only €420 million – or 42 percent of the headline cut.  This is extremely inefficient.  In percentage terms, the deficit would fall by only 0.23 percent.  That’s all.

Whatever the reasons for cutting public sector employment, reducing the deficit is not one of them.

 Public Sector Pay

The ESRI did the same exercise with cutting public sector pay by €1 billion (or approximately 6 percent).  While the deflationary impact is not as high, it is also inefficient at cutting the deficit.

• Impact on domestic growth:  ‘Saving’ €1 billion would reduce GNP by €700 million, or 0.5 percent by 2015.

• Impact on employment:  there would be a loss of 3,700 jobs.  These would be private sector jobs, lost through reduced domestic demand.

Naturally, consume spending would also be hit – almost as severe as cutting public sector jobs.  Consumer spending would be cut by over €950 million.

After all this, the impact on the deficit would be minimal.  By 2015, the deficit would be reduced by €479 million – or 0.26 percent.  This is approximately the same impact as cutting public sector jobs.

What Could Happen

The Government has stated that they are looking for a mix of pay and job cuts in the public sector.  So let’s use the ESRI numbers to estimate the impact of €1 billion ‘savings’ with half coming from both wage and jobs cuts.

Over a billion Euros is lost in growth and consumer spending, nearly 12,000 jobs lost; and the deficit falls by only 0.2 percent. 

Of course, models are not very nuanced.  They just take numbers on the large stage and apply them through a number of indicators.  For instance, what happens if you cut the pay of higher-income earners?  The impact on demand would be less, so the damage to the domestic economy would be reduced.  But the revenue gain could, ironically, be even less – in particular, given that the marginal tax rate of high-income public sector employees is 62.5 percent (tax plus pension levy).  So a €1 billion cut would reduce direct tax/pension levy revenue by €625 million – and that’s not counting the loss from spending taxation. Given that there are only 6,800 public sector employees earning over €100,000, there’s not much change in that.

But a real problem with these estimations is that they were made in 2010.  The base-line the ESRI used was one of modest growth (from the World Recovery Scenarios).  What might such estimations look like against a base-line of lower growth and following on from substantial cuts in pay and jobs?  It could be reasonable to assume that the risks to these estimations are on the down-side – that is, if they change, they are likely to change for the worse.

This raises fundamental questions:  is the large economic price worth the small fiscal gain?  Is there a better way of reducing the deficit?  And is the best suggestion that the Government can come up with?

We elected a new Government but all they did was to take over Fianna Fail policy – a policy of down-sizing.  A new Government could have taken a step back, tested these policies against the best available evidence, and engaged in some new thinking.  They didn’t.  Its’ all rote and automatic pilot.

If we can’t elect another new Government, can we at least elect some new ideas?

 

 

Comments

[Colum McCaffery]

This argument is so plausible you have to wonder why it isn't universally accepted. I think there are two reasons. Firstly, it faces those who have a religious belief in a minimal state. Secondly and more importantly, most of those who demand cuts in the public service do so not because they find your argument unconvincing but because they have views on conditions and pay in the public srvice. Now, most of those views are possibly prompted and certainly nurtured by media lies but they are the main reason your argument faces opposition.

[CMK]

Micheal, another humane piece that deserves the widest possible dissemination. One thing that struck me about the Croke Park shadow boxing was the whole idea of 'more hours for the same pay'. Hopefully, the trade union negotitators have no truck with this (though I suspect they will). One would have thought that it would a non-negotitable stance that if there is a demand that a workforce work more hours, that's an implicit acknowledgement that they are currently working at or above their limits and the best way to resolve this is to hire more staff! A government slap bang in the middle of an unemployment catastrophe should surely be looking to take people of the dole to do work it itself knows is there to be done; not trying to sweat a few extra hours out of existing staff like some 1830's Lancashire mill owner. It should be a no-brainer, but it's not and we're likely to have public sector workers working hours that could be done by tens of thousands currently on the dole. Marx's aphorism 'history repeats itself, first as tragedy and then as farce' have rarely been more apposite.

[Michael Taft]

Colum - you are correct. Facts and some people's worldviews rarely mix. However, there may be another category - one that doesn't go along with downsizing but unable to critique to provide a proper critique, never mind an alternative.

CMK - yes, increasing hours is another form of reducing employment. You're right - increasing employment would appear to be the best way forward, but there are, as Colum pointed out above, people who want to downsize. And there's people who don't know how to think their way through. If there is unproductive activity in the public sector, one can reduce that and increase the productive sectors. But we are far away from that debate.

[Hugh Sheehy]

Of course, if we cut spending in the existing public sector there'd be some money to stimulate jobs in the rest of the economy. It'd have an even bigger impact on jobs.

Let's see the unions propose that.

Meantime, proposals to maintain supra-normal pay in the public sector are just naked self interest - and hang the consequences for anyone else.

[Ciaran]

Hugh,

Don't you think that if jobs could be stimulated by public sector cuts, we would have seen evidence for that by now? In this or any country? At some point in history?

Say what you like about the unions' grasp of economics, but I'm glad to say they wouldn't be likely to propose this idea.

[Daren]

The fact is that there is a massive management overhang in areas of the public service. The HSE is a particular offender here. There is also an administrative overhang, again the HSE is a major offender.

The conflating of "the public sector needs trimming" with "sack all the nurses" needs to stop. There genuinely needs to be a refocusing of the available resources towards the actual front-line.

I also don't see what's objectionable about being able to make non-performers redundant. It's absurdly difficult at the moment to fire people even despite shocking attendance records and poor working levels.

I have two other brief points.
1. Areas of the public service take their performance goals as "maximums - do not do any more than this" (I have experienced this personally). This attitude must stop, because it's contagious (and indeed, exceeding these targets can be met with extreme hostility).

2. Union groups representing both managers and those they manage is an inherent conflict of interest and should be barred.

[Tomboktu]

You're using ESRI projections, not NERI ones, presumably because that is what is available to you.

A few years ago when I heard that Congress was getting extra economists, I cheered. Then when I heard it wasn't quite that, but rather Congress and member unions were funding an independent economic think-tank, I groaned. We need NERI analyses and back-up, in the thick of the fight, not another tink tank.

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