Governmental employers may well find it increasingly difficult to retain and recruit high quality workers because of the growing gap between salaries in the public and private sectors – warn Jonathan Cribb and Luke Sibieta

Last week, the Office for Budget Responsibility released its latest forecasts for the United Kingdom economy including its forecasts for public sector employment and pay. These have important implications for the public sector in the coming years.

First of all, with the British Chancellor George Osborne choosing to pencil in further cuts to departmental spending in 2018–19, last week the OBR suggested that there would be a further 130,000 body-count fall in general government employment – that is employment in Whitehall and across the civil service, and local authorities – in 2018–19, bringing the total drop to 1.1 million between 2010¬–11 and 2018–19.

Despite the scale of these cuts, it was not the reductions in government employment that really stood out. Instead it was the reductions to forecast growth in public sector pay. Public sector pay is now forecast to be 3.6 per cent lower in 2017–18 than expected in June, when analysis at the Institute for Fiscal Studies used the OBR’s March forecasts and incorporated an estimate of the effect of the 1 per cent pay award in 2015–16.

This change of view in part reflects the fact that earnings growth in the public sector has been weak so far this year, with no growth in pay in the 3rd quarter of 2013 compared with the same quarter a year before. This has led the OBR to reduce its forecast for public sector pay growth in 2013–14 to only 0.5 per cent compared with a forecast of 2.2 per cent in March. It has also reduced its forecast for each year up to 2016–17 compared to the March forecast.

At the spending round in June, based on the forecasts then available, our researchers remarked that the headline public-private pay gap was likely to return to its pre-recession level by 2015–16. This was after public pay had grown faster than private pay during the recession. The latest forecasts now suggest an acceleration of the fall in public pay relative to private.

The pay differential is predicted to return to its 2007–08 level – and the level seen in 2008–09 – this year, some two years earlier than previously forecast. Furthermore, OBR projections imply that public sector pay is set to grow less quickly than the private sector in each of the years after 2013–14 too. This implies that by 2018–19, public sector pay is predicted to be 6.4 percentage points lower relative to private sector pay than it was before the crisis in 2007–08.

Importantly, the recent trends in average public sector pay relative to private sector pay do not appear to be driven by a change in the composition of the workforces. Even after controlling for observed differences in individuals’ age, sex, experience and education, the trends in the differential between public and private sector pay in recent years are little altered.

If, as these projections suggest, public sector pay is set to fall relative to private pay by 8 percentage points between 2012–13 and 2018–19, it seems likely that these wages will fall lower relative to private pay than its level in the early 2000s; when parts of the public sector had difficulties recruiting and retaining staff. This has some important implications.

First, if the current forecasts are correct and private sector earnings growth continues to be higher than public sector earnings growth, some public sector employers may well find it increasingly difficult to retain and recruit high quality workers. Second, if that leads the government to want to mitigate the squeeze in public sector pay but to keep workforce costs as planned it would have to absorb even more cuts to the size of the workforce, beyond the cuts of 1.1 million already planned between 2010–11 and 2018–19.

In making such decisions, both the government and pay-review bodies need to pay great attention to indicators of whether the public sector is facing any difficulties in recruiting and retaining high-quality staff, and decide on settlements in light of any such evidence. While public sector pay relative to private sector pay was forecast to return to its pre crisis level by 2015–16, squeezing public sector pay may have been a relatively easy way to cut departmental spending. Given the current OBR forecasts, the choices ahead for the government now look rather harder.

Jonathan Cribb is a research economist at the British-based Institute for Fiscal Studies think-tank and Luke Sibieta is a programme director at the same organisation