The ever-increasing gap between public and private sector pay

I presented what they call an ‘authored piece’ for the BBC this week (it’s on UK growth and you can listen to it at 10:00 on Thursday on Radio 4). Part of it involved going to a golf club in Edinburgh and chatting with some of the UK’s happy retirees.

The golfers I talked to were all well off; they had all more or less retired well before 65; they owned their homes; they had spare cash and capital; and they were devoting themselves to pleasure – mostly in the form of playing golf, going on holiday and spoiling their grandchildren.

They all agreed that they had been tremendously lucky to live through a long period of fast economic growth and huge rises in asset prices – to be part of the ‘lucky generation’. But as we talked, it became clear that the key factor behind their prosperity was the same for all of them – a final salary pension.

They knew – and had known for some time – that they were living low risk financial lives. Whatever happened (barring a breakdown of the state, etc) they would get an inflation-linked percentage (mostly 66% but one was getting 75%) of their final salary at retirement every year, for ever.

This made me so envious I could hardly bring myself to be gracious: there is no way, however hard I work or well I invest that I can ever imagine finding myself in possession of a guaranteed inflation-linked income of anywhere near what these charming ex teachers (in two of the cases) were living on. No way.

An income of £25,000 a year, inflation linked – to RPI –  would currently cost around £1m (numbers taken from the Annuity Bureau); £20,000 would be £800,000; and even £15,000 would be £600,000. I’m just not going to have the money to buy this kind of annuity. Nor will the vast majority of my private sector colleagues.

Public sector employees (pretty much the only people left who will now get inflation- and salary-linked pensions) will say that there is a trade-off here. Private sector employees tend to get paid higher base salaries than public sector employees, something that makes them better off than public sector employees.

This is a good line – and it used to be true. The problem is that it isn’t true any more. In fact, on ONS numbers (which accept that this stuff isn’t easy to measure), excluding pensions, the average public sector employee is paid well over 7% more than the average private sector employee. Public sector salaries are also rising even as private sector salaries are frozen. Add in pension benefits, and its tough to even begin to argue that the public sector is worse off than the private.

The perception problem here, I think, is very often down to mild innumeracy. So here’s what I’d like to do: I’d like to change the way that salaries are quoted completely. Instead of quoting one cash number and a list of benefits, we should all always be obliged to quote a package value – that includes the deferred income of pensions.

So let’s make a really simple example, leaving all the numbers at present values. Let’s say we have one public sector worker starting work on £16,000 a year at 22. He works for 40 years and sees his salary rise by inflation plus 3% every year so that he ends on £52,200. His total gross salary has been £1,242,613, or an average in the end of £31,065 a year. Let’s say he then retires on a final salary pension of £34,000 (2/3 of his final salary). The cost of that salary on the open market would be £1,360,000.

The point is that while he was paid the £1.24m in salary, he was also being effectively paid a deferred income of £1.36m over the same period, making his total compensation well over £2.6m and his average annual salary average salary more like £65,000 than £31,000.

If he was on an average final salary pension, these numbers would be lower, but still very high (2/3 of £31,000 is around £20,500 and buying that as an annuity would cost well over £800,000). These numbers are just for illustration so please don’t waste your time demolishing them below (I know that most public sector workers make a contribution to their pots as do private sector workers, for example..). I’m just trying to show that salaries aren’t just about current income, they are about deferred income too.

This is something that needs to be made very clear to everyone – I suspect that if sums of this type were done for public sector employees they might be better able to compare their pay to private sector pay and perhaps start feeling rather less hard done by than they do at the moment (and possibly at many levels of salary even rather lucky – just as my golfers do).

I also suspect that we might find ourselves on a path by which we could find a way to actually cut state spending – see my post here from 2010 on how cutting high end salaries across the board is the quickest way to slash the deficit. I might add to it now, of course, that leaving current incomes where they are and having a better go at slashing deferred income rights might work too.
 
More on this here, where the wonderful Ros Altmann does the sums, showing that the average public sector pension accrual is worth an extra £150 a week in salary.