– Robert Nielsen discusses the ongoing dispute over the Croke Park II proposals, and why cutting wages is always a bad idea.

At the moment there is a great deal of controversy over the Croke Park Deal. In essence the government is trying to cut the wages of public sector workers while the public sector unions are opposing this. Regardless of the politics of the agreement, cutting wages is bad economics. It depresses the economy, worsens the recession and doesn’t even achieve its objective of reducing the deficit. The union membership was absolutely right to reject the Croke Park Deal and the government must completely reconsider its plan of action, because the current one isn’t working.

Cutting people’s wages doesn’t work for the simple reason that we are all connected. You see if you cut (say) a teacher’s wages, you think you are saving money, but you really aren’t. That teacher now has less money and so cuts her spending. Let’s say she cancels bringing her car to be repaired. However, this means that the garage now has less money and if enough people stop spending money, it will have to fire some staff or even close down. This means these people now have less money and therefore spend less, meaning the economy suffers even more, leading to more cutbacks, which makes things worse and so on. It’s a downward spiral that makes the economy worse and worse.

These newly unemployed people are no longer paying tax but are instead receiving welfare so the government doesn’t even achieve its goal of reducing the deficit. As there is less spending, less revenue from VAT and other excise taxes are raised. Therefore a cut in public workers wages does not reduce the deficit or produce “savings” as is often claimed. Instead it worsens the recession, increases unemployment and doesn’t even save the government any money. It is for this reason that despite half a decade of austerity, the economy is still stuck with high unemployment, low growth and a deficit that has barely reduced after successive budgets containing billions of cuts.

This is why public pay cuts are such a terrible idea. They cause great hardship among hard working honest people who did nothing to cause the financial mess but are unfairly being asked to pay for it. In 2009 there was the pension levy, which instead of saving money merely pushed the economy deeper into recession. Then there were the 2010 pay cuts, which depressed consumer demand while raising little revenue. Eventually we have reached a point where enough is enough and no more blood can be taken from this stone. Public sector workers have been battered enough without any improvement in the government finances. If a deal is made that cuts public sector pay, it is only a matter of time before it depresses consumer demand and the government comes knocking on the union’s door looking for more cuts.

Let’s try and put the above theory into practice. How many jobs are we talking about? It is extremely difficult to estimate (for obvious reasons) but the ERSI has made an attempt. Between 2008 and 2012, 29,525 public sector jobs have been cut. That this alone has happened in a time of exceptionally high unemployment would be damaging enough, but it has had knock on effects to the rest of the economy. At the very least 12,000 private sector jobs have been lost as a result. This is an underestimate as it assumes a growing economy (with a stagnant economy, the effects are worse) and it only measures the initial effect and not the negative spiral I discussed above. This should dispel the myth that the private sector is somehow safe and protected from public sector job losses. Public and private are not two separate sectors of the economy, but rather interlinked and dependent on each other. When one suffers, so does the other. So the governments cutting of public sector jobs should not been seen as only affecting one section of the economy, but rather a short sighted move that has cost 40,000 jobs throughout the economy.

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It is also a myth that cutting wages saves the government money. In reality, although pay cuts cause a great deal of pain, they produce very little gain. If the government cuts a workers wage by €100, it does not save €100. This is because a large part of everyone’s wage is paid in tax. If you cut a low paid workers wage by €100, you only save €65 because you lose out on the 35% (20% income tax, 11% USC/PRSIA and 4% pension levy) of their wage that is paid in taxes. If they are higher paid then a €100 cut only leads to a €43 saving as their tax rate is 57% (40% income tax, 11% USC/PRSI and 5.6% pension levy). So roughly speaking a public sector pay cut only “saves” half that amount. This is without considering the reduced spending and therefore reduced Vat revenue etc. The ESRI has shown that for every €100 that is cut from public workers wages, consumer demand falls by €73.

Using this data it has been estimated that a pay cut of €1,000 leads to a net saving of only €488. Thus if the government cut public sector pay by €1 billion, it will only reduce the deficit by 0.26% of GDP. In other words, there will be a large amount of pain inflicted with little benefit.

Despite half a decade of austerity, the deficit has only fallen by 1% of GDP. So the next time someone says that we must cut wages to reduce the deficit, remind them that we have cut wages repeatedly and it has failed. Tell them that if they want to reduce the deficit, they will have to try a different method, preferably one that actually works.

What other ways are there? One proposal is to invest rather than cut. This has many advantages such as boosting the economy and reducing unemployment (which at 14% should be our main priority). Not only that, but it can also reduce the deficit. If people have jobs they are no longer receiving welfare benefits and thus spending will go down. With a job they will be able to pay tax and therefore increase government revenue. In fact the main reason for the current budget deficit is not reckless spending, but rather a collapse in revenue, caused primarily by job losses. The simple fact of the matter is that it is not possible to balance the budget while the economy is suffering from massive unemployment.

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The above and below charts show the difference of approaches. A €1 billion cut will only reduce the deficit by €600 million while reducing growth and increasing unemployment. A €1 billion investment programme on the other hand, will not only boost economic growth and create jobs, but it will also reduce the deficit more than cutting wages. It’s a win-win. The government is wrong when it pretends there is no alternative to its actions, that pay cuts are inevitable. There is always an alternative. We have a choice between painful cuts that will deepen the recession or an investment programme that will boost the economy, lift us out of recession, create jobs and reduce the deficit.

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Even if you reject the investment programme, there are other alternatives that are more effective at reducing the deficit without undermining essential services. A 3rd tax rate could be introduced or a wealth tax could be levied. Both of these would ensure that the poorest sections of society are not hit the hardest (as in previous budgets) and everyone makes a fair and equitable contribution (instead of just targeting public sector workers). As can be seen from the chart below, each proposal reduces growth and causes job losses, but Croke Park proposals are by far the worse. They reduce the deficit by the least while costing twice as many jobs and twice to treble the loss of growth. Cutting public sector pay is a terrible idea that gets the worst of both worlds.

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http://crokeparkreport.wordpress.com/2013/04/04/an-alternative-to-a-chilling-threat/

So, no, cutting public sector pay is never a good idea. The government will probably try to negotiate a new deal with the unions, but any deal that includes pay cuts will fail. It will cause great hardship, it will increase unemployment and it will reduce growth. It will depress consumer demand and make the recession worse. It will even fail to reduce the deficit. It is said that the definition of madness is trying the same thing again and again, and expecting a different result. The government has tried cutting wages again and again, only to see the economy stagnate and little reduction in the deficit. So they are reduced to repeating the same failed methods despite the evidence showing that it will not work. The government needs to stop cutting wages and start growing the economy. It’s time to try the alternative.

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