2 August 2022

Crowding out: how regional pay bargaining can boost levelling up

By Elliot Keck

Levelling up has been on the lips of every candidate in the Conservative Party leadership contest. Each was expected to outline, if not a clear and coherent strategy, then at least a vague roadmap for achieving this nebulous but much promised goal. As we have seen with Liz Truss recently, there will be a lot of talk about the role that public investment must play in driving up productivity and prosperity in some of the UK’s forgotten regions.

Under Boris Johnson we have seen a cornucopia of funds, grants and schemes – all in the hope that a cocktail of equal parts lofty rhetoric and eye-watering sums of money will finally rebalance the UK’s economy, with town catching up to city and north gaining pace with south.

It would be a brave candidate who puts their hand up and asks not just whether this spending is the best use of taxpayers’ money, but whether it may actually make the situation worse. Because there tends to be a correlation between high public spending and poor private sector performance.

This idea is not new. Known as the ‘crowding out’ effect, the theory is that rising public sector spending drives down private sector activity. This is because of the impact that government financing for higher spending has. Government can only fund higher spending through borrowing or taxes. Both come at the expense of private sector investment. When government borrows, that’s money that could have been used to fund private sector investments. When government taxes, the private sector sees profits squeezed.

But there is a further angle to this: government spending does not just impact the availability of capital. Government spending also impacts the far more constrained availability of labour. Because the more government pays its staff, the less desirable the private sector is as a place to work. It’s a problem that the Truss campaign has correctly acknowledged in their policy announcement today. And the TaxPayers’ Alliance’s latest research into regional pay bargaining finds that it may be a very serious problem indeed.

Firstly, what is regional pay bargaining?

The best place to start is to explain its opposite: national pay bargaining. National pay bargaining is the current centralised way of determining public sector pay awards, via the public sector pay review bodies. It differs slightly sector by sector, but essentially what it means is that decisions on pay for public sector workers are taken on a national level, regardless of regional conditions. The only exception is London, where a pay premium is applied. Regional pay bargaining by contrast would mean that pay decisions are taken on a region-by-region basis.

Under national pay bargaining, little attention is paid to regional conditions such as cost of living and unemployment. The results are highly distortionary. Compare the pay of civil servants in London to civil servants in the North East. In London, executive officers (the second most numerous pay grade) receive a median salary of £30,110, compared to £27,570 in the North East. Then compare these to the median salaries for private sector jobs. In London, the median private sector salary is £33,656, a healthy 10% higher than the median salary for an executive officer. But in the North East it’s just £21,644. That’s 20% lower than the salary of an executive officer in the region. Even for the lowest paid civil service job, an administrative officer or assistant, the median salary in the North East is £21,010, only marginally lower than the median private sector salary in the region and with the added bonus of a public sector pension.

It’s no wonder that the private sector cannot compete in the North East. And the data is similar for the rest of the country. A clear picture emerges: left-behind areas are defined by public sector pay outstripping private sector pay.

The most recent data we have on pay rises highlights the deteriorating situation. In Scotland, in 2021, public sector workers were treated to a bumper 9.7% pay rise. In the North East they took home a still handsome 6.6%. Their private sector counterparts didn’t just fail to keep pace with these pay rises. Instead they suffered painful cuts to their wages, with Scottish workers seeing pay fall by 4.4% and north-eastern workers being forced to swallow a 5.1% deduction. These are completely unsustainable numbers.

Particularly interesting is the data for the senior civil service. These are the sorts of workers that should be at the top of their game. The sort of people that would be expected to set up businesses or run them at high levels. And yet the incentives in so much of the country are to go straight for a public sector role. Remarkably, London is in the bottom half for median salaries for the senior civil service level. The East Midlands, East of England, Scotland, West Midlands, South West, and South East are all higher. Why go into business when the life of the bureaucrat gives you so much bang for your buck – plus all the other benefits that come with that.

Regional pay bargaining then would not just be good for the taxpayer, as it could save up to £8.8bn per year. It would also help truly drive levelling up in the regions. By bringing public sector pay into line with levels where the private sector can compete, the promise of levelling up can perhaps truly be realised by business (not just public) investment.

Because it is only private sector investment that can guarantee prosperity for the long term. It is only the private sector that creates the wealth which translates into higher incomes for workers, and improved tax receipts to fund public services. The best way to help the private sector? Stop crowding it out.

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Elliot Keck is Investigations Campaign Manager at the TaxPayers’ Alliance

Columns are the author's own opinion and do not necessarily reflect the views of CapX.