Sunday 7 March 2010

The cost of the public debt

   In a week marked by protests and discussions about pay rises in the public sector, many have argued that civil servants are to be held responsible for a disproportionate share of the public debt under proposals of a pay freeze.
   But that is a rather unconvincing claim. The outside option for civil servants is the best between unemployment and employment in the private sector, if available. Its value decreases during periods of slow or negative economic growth with the higher risk of unemployment and downward pressure on private sector earnings.
   Civil servants may not be too sensitive to negative changes in the value of their outside option since their contracts cannot be ended by the public employer nor can new contracts be drawn in different terms from existing ones. But their wage claims are likely to be unwelcome in a private sector facing the adversities of recession and unwilling to make further contributions towards a group of workers highly insured against such adversities.
   The government bargaining power is strongly determined by the popularity of its position. And by the ability of opposition parties with governing ambitions to argue against it. As a consequence, meaningful pay rises are unlikely independently of the state of public finances in a period characterised by a mainly exogenously driven recession. That the public debt raises concerns and external pressures to control it just reinforces the government position.
   More likely, hiring in the public sector may follow the downturn and support the effort to control public expenses. Eventually, efficiency gains may be obtained with some re-organisation of public services. But the consequent drop in labour demand just intensifies the climate of job shortage, possibly carrying a high cost for unemployed workers and those not covered by strong employment protection.

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