ECONOMIC INSIGHTS

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ECONOMIC

INSIGHTS

PUBLIC SECTOR PAY -

AVOIDING THE

MISTAKES OF THE PAST

MARCH 2017


Conall Mac Coille

Chief Economist

Conall joined Davy as Chief

Economist in 2010. Prior to

that, he worked for eight years

as a monetary policy adviser

and senior economist at the

Bank of England. He has also

worked at the Economic and

Social Research Institute,

Dublin, and as a lecturer at the

Dublin Institute of Technology.

He received his BA and MA

in Economics from University

College Dublin.


CONTENTS

PUBLIC SECTOR PAY POLICY UNDER SCRUTINY

HOW BIG IS IRELAND’S PUBLIC/PRIVATE PAY GAP?

WHAT SHOULD THE PUBLIC SECTOR PAY COMMISSION RECOMMEND?

PUBLIC SECTOR PAY THROUGH IRELAND’S BOOM AND BUST

ARE IRELAND’S PUBLIC SECTOR PAY LEVELS

HIGH BY EUROPEAN STANDARDS?

CAN WE EXPLAIN THE GAP BETWEEN PUBLIC

AND PRIVATE SECTOR WAGES?

HOW SHOULD WE VALUE IRISH PUBLIC SECTOR PENSIONS?

A MORE FLEXIBLE FORM OF PAY BARGAINING

IMPORTANT DISCLOSURES

REGULATORY AND OTHER IMPORTANT INFORMATION

05

06

08

09

11

14

17

19

20

21


EXECUTIVE SUMMARY

In the first of our Economic Insights series of white papers, we consider the vexed question

of public sector pay in Ireland. The overwhelming evidence is that public sector pay rates in

Ireland are unusually high relative to the private sector and by European standards. Hence, any

successor to the Lansdowne Road agreement should limit pay rises. Also, given the uncertainty

of Brexit, pay rises should be conditional on the on-going performance of the economy.

Negotiations on a successor to the Lansdowne

Road Agreement are set to begin in the first half of

2017. Ahead of these negotiations, the government

has tasked a newly established Public Sector Pay

Commission (PSPC) to assess appropriate pay

levels. In this white paper, we consider the evidence

on how Irish public sector pay levels compare with

those of the private sector and with other countries.

Our key findings on public sector pay

The Public Sector Pay Commission must highlight

gaps in pay and pension provision

Our view is that public sector pay (including the

positive impact of increments) should at most

rise in line with the private sector. Ideally, the pay

gap should close over time. Public sector pay

rises should also be conditional on the on-going

performance of the economy and tax revenues,

guarding against the risks from Brexit, corporate tax

reform and other economic uncertainties.

ππ

Average public sector wages are €47,400

in Ireland, 40% higher than in the private

sector before allowing for differences in

pension entitlements and job security.

ππ

At most, around half of this pay gap (20%)

can be attributed to differences in education,

experience, qualifications and other factors.

ππ

ππ

ππ

ππ

In the United Kingdom, average public

sector wages are £26,200 – almost exactly

in line with the private sector (£26,300) and

lower than in Ireland.

Ireland’s public/private pay gap is high by

European standards, similar to southern

European countries. Lower-paid public

servants benefit most from the pay gap.

The public sector enjoys retirement benefits

that need to be taken into consideration. Our

calculations indicate that a private sector

worker would need to save €590,000 to

buy an annuity that matched public sector

career-average salary pensions of €23,000

per annum.

At current annuity rates, a pension that

provided €22,000 of annual income (above

the contributory pension) would cost

€1 million.

4


■ ■ ■ DAVY | ECONOMIC INSIGHTS | PUBLIC SECTOR PAY – AVOIDING THE MISTAKES OF THE PAST

PUBLIC SECTOR PAY

POLICY UNDER SCRUTINY

Once again, the issue of public sector pay looks set

to dominate the newspaper headlines. The newlyestablished

PSPC is set to report on how public

sector pay levels compare with those of the private

sector and relative to other countries. The report

is intended to provide critical, evidence-based

insights to inform fresh negotiations, scheduled to

begin in the first half of 2017, to replace the existing

Lansdowne Road Agreement.

The Commission’s report is bound to be contentious.

Most objective analyses have found public sector pay

levels are unusually high relative to the private sector.

These include studies by the Central Statistics Office

(CSO), Economic & Social Research Institute (ESRI),

European Central Bank (ECB), European Commission

(EC) and many other economists.

Calls for a new form of public sector pay setting

have also reflected a dissatisfaction with the

current opaque bargaining arrangements. The Irish

Small and Medium Enterprises Association (ISME)

has called for pay setting to be removed from the

political arena. Many economists are concerned that

the government’s fiscal position could be damaged

if it gives in to demands for ‘pay restoration’ 1 .

Minister for Public Expenditure and Reform Paschal

Donohoe has directed that the PSPC will have

to examine the value of public sector pensions.

This is the first time public sector pensions will be

considered in the context of a pay agreement. The

PSPC report will also surely draw attention to the

worrying fact that less than 50% of private sector

workers have any private pension provision.

The Irish Congress of Trade Unions (ICTU) has

said that ‘while international and public-private pay

comparisons could inform public service pay policy

in the longer term’ the priority should be on restoring

public sector pay rates to Celtic Tiger era levels.

“Most objective analyses have found public sector pay levels to be unusually high

relative to the private sector”

1

See interview with John Fitzgerald,

http://www.independent.ie/irish-news/politics/if-you-raise-public-sector-pay-and-taxes-the-rest-of-the-economy-loses-35335077.html

5


HOW BIG IS

IRELAND’S PUBLIC/

PRIVATE PAY GAP?

The average Irish public sector wage was €47,400

in 2016, 40% higher than in the private sector. At

most, around half of this pay gap (or 20%) can be

attributed to differences in education, experience

and qualifications. Average public sector pay in

the UK is £26,200 (€30,800) – almost exactly in

line with the private sector and far below levels in

Ireland. Ireland’s public/private sector pay gap is

on a par with southern European countries such as

Italy, Greece, Portugal and Spain.

The public sector also enjoys retirement benefits

that need to be taken into consideration. On our

calculations, a private sector worker would need

to save a €590,000 pension to match the same

€23,000 paid per annum to public sector workers

when they retire on a career-average salary scheme.

The figures are higher for those with defined benefit

pensions linked to their final salary.

Figure 1: Irish and UK public/private sector wages, €000s

50

000s

47.4

45

40

35

30

33.9

30.7

30.8

25

20

Private Sector

Ireland

United Kingdom

Source: Central Statistics Office; Office for National Statistics

Public Sector

Table 1: Irish and UK average annual earnings

Public sector

Private sector

Average annual earnings

Ireland €47,400 €33,900

UK (€) €30,800 €30,700

UK (£) £26,200 £26,300

Average hourly earnings

Ireland €28.1 €20.3

Source: Central Statistics Office; Office for National Statistics

6


■ ■ ■ DAVY | ECONOMIC INSIGHTS | PUBLIC SECTOR PAY – AVOIDING THE MISTAKES OF THE PAST

There is a wide distribution of wage rates across

the public sector (see Figure 2 and Table 2). An

Garda Síochána had the highest average pay in

2016 at €64,700, followed by semi-state companies

(€53,300) and education (€47,600). The Defence

Forces had the lowest average pay in the public

sector at €42,000 but were still above the

€33,900 private sector average. A key point here

is that we are looking at what is actually paid to

workers. Pay scales in the public sector are often

unrepresentative of actual earnings due to a myriad

range of allowances, reliefs and other payments.

Figure 2: Average public sector earnings by sector

€000s

An Garda Síochána

Semi-State companies

Education

Total Public Sector

Health

Civil service

Regional bodies

Defence

35 40 45 50 55 60 65

Regular Earnings

Irregular Earnings

Source: Central Statistics Office

“The average

Irish public

sector wage

was €47,400

in 2016, 40%

higher than

in the private

sector”

Table 2: Earnings across the public and private sectors (€)

Source: Central Statistics Office

Annual

Earnings

Hourly

Earnings

Annual

Earnings

Hourly

Earnings

Public sector €47,400 €28.1 Private sector €33,900 €20.3

Defence €42,000 €22.7 Hotels & Restaurants €17,300 €12.5

Regional Bodies €43,400 €23.4 Other Services €24,400 €16.7

Civil Service €45,100 €24.6 Admin & Support €27,100 €17.4

Health €45,200 €25.2 Wholesale/Retail €28,600 €17.8

Education €47,600 €37.7 Construction €38,300 €19.8

Semi-state €53,300 €27.7 Transport €39,400 €21.0

An Garda Síochána €64,700 €29.1 Professional & Scientific €44,500 €25.4

Industry €44,800 €22.4

Finance €54,400 €29.7

Information &

Communications

€56,200 €29.8

7


WHAT SHOULD THE PUBLIC

SECTOR PAY COMMISSION

RECOMMEND?

We believe the PSPC must grasp the nettle of

acknowledging that public sector pay rates in

Ireland are high by international standards and

compared to the private sector. Therefore, any

successor to the next Lansdowne Road Agreement

should ensure the following:

ππ

ππ

ππ

Growth in public sector pay per employee

(including the positive impact of

increments) should at most only match pay

rises in the private sector.

The value of pensions should be included

in any comparison of public and private

sector pay.

Any planned multi-year pay rises must

be conditional on the performance of the

economy.

Ideally, the public/private pay gap should be allowed

to close over time. However, because the pay gap

is larger for lower-paid public servants, this will be

politically difficult to achieve. As a second-best

option public sector pay growth should be limited

to ensure the gap does not widen over time. In this

vein, some of the steam in the debate on public

sector pay could be ameliorated if a value is put on

public sector defined benefit pensions.

The Department of Finance has argued that wage

setting should be as flexible as possible. We agree.

Any multi-year agreements on pay must be made

conditional on the on-going performance of the Irish

economy and tax revenues. A flexible agreement

would be prudent given the risks posed by Brexit,

questions on the sustainability of corporate tax

revenues and the inherent volatility that is always

faced by a small open economy such as Ireland.

There is also a question on whether centralised

wage agreements for the public sector are

appropriate. In the UK there are separate processes

for different parts of the public sector which may

help prevent inappropriate ‘relativities’ between

sectors imposing an additional rigidity on pay.

“In this vein, some of the steam in the

debate on public sector pay could be ameliorated

if a value is put on public sector

defined benefit pensions.”

8


■ ■ ■ DAVY | ECONOMIC INSIGHTS | PUBLIC SECTOR PAY – AVOIDING THE MISTAKES OF THE PAST

PUBLIC SECTOR PAY

THROUGH IRELAND’S

BOOM AND BUST

In recent decades, public sector wages in Ireland

have been set by centralised wage agreements

known as ‘Social Partnership’. The first agreements

were part of a broader package of economic

reforms, supported by the ‘Tallaght strategy’ –

where the Fine Gael party supported Taoiseach

Charles Haughey’s Fianna Fáil minority government.

These early agreements delivered modest pay

growth and limited industrial unrest during the

1990s. By the turn of the millennium, centralised

wage bargaining was seen as an intrinsic part of

Ireland’s economic progress.

However, Social Partnership became synonymous

with excessive increases in public expenditure

during the Celtic Tiger period. The public sector

pay bill more than doubled from €8.9 billion in 2000

to €21.1 billion by 2008 and grew even faster than

the economy, rising from 8.2% of Gross Domestic

Product (GDP) in 2000 to a peak of 12.2% in 2009

(see Figure 3).

The 2002 benchmarking exercise will go down as

the nadir of the Social Partnership era. Despite little

evidence that public sector wages had been ‘left

behind’ by the private sector, the Public Service

Benchmarking Body awarded an enormous 8.9% rise

in pay on average across the public sector.

In fact, a study by former Davy Chief Economist Jim

O’Leary and colleagues showed that public sector

workers were paid 13% more than their private

sector counterparts in 2001 (after accounting for

differences in education and qualifications), showing

little had changed since the early 1990s. Not for the

first time, the political narrative trumped the facts

on public sector pay.

Figure 4 shows that average public sector earnings

grew from €31,800 in 2000 to €48,000 by 2007 – a

50% increase – widening the gap with the private

sector. The financial crisis led to an inevitable

correction in public sector pay under ‘The Financial

Emergency Measures in the Public Interest’ (FEMPI)

acts. These included a pension levy (worth 7%

of pay on average) and a straight pay cut of 6%

implemented in 2009. In 2013, public sector workers

earning over €65,000 received a further 6% pay cut.

Figure 3: Ireland’s public sector pay bill and public sector employment

340

000s

Billion

25

320

20

300

280

15

260

10

240

220

5

200

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Public Sector Employment - Full Time Equivalents (left axis) Public Sector Pay Bill (right axis)

Source: Central Statistics Office; Department of Public Expenditure and Reform

0

9


However, despite these cuts, Figure 4 shows

that average pay in the public sector in 2016

was €47,400, just 4.2% below the 2009 peak of

€49,500. A recent study by University College Cork

economists found that the pay of the bottom 25% of

income earners in the public sector actually rose by

7.4% 2 but fell by 4.9% for the top 25%.

These figures highlight the positive impact of

increments (automatic pay rises linked to years of

experience) and various reliefs and allowances on

public sector pay levels. Incomes have not fallen as

sharply as the headline reductions under the FEMPI

acts. The PSPC will have to judge calls for ‘pay

restoration’ in light of these facts.

Perhaps the most telling summary statistic is

that the overall size of the public sector pay bill is

expected to rise to €20.6 billion in 2017, a level last

seen in 2008. This is despite total employment in

the public sector currently at 368,100, down from a

427,300 peak in 2008. 3

Figure 4: Average annual earnings – public sector and total employment

55

€000s

50

45

40

35

30

25

20

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Public Sector Total Employment

Source: Central Statistics Office; Department of Public Expenditure and Reform

“Actual public sector pay levels have not been cut as sharply as the headline FEMPI

measures suggest”

10

2

See ‘An Analysis of Public and Private Sector Earnings in Ireland, 2008-2013’ by Justin Doran, Noirin McCarthy and Marie O’Connor, School of

Economics, University College Cork.

3

The Department of Public Expenditure and Reform indicates there were 298,200 full-time equivalents in the public sector at the end of 2015, down

7% from 320,400 in 2008.


■ ■ ■ DAVY | ECONOMIC INSIGHTS | PUBLIC SECTOR PAY – AVOIDING THE MISTAKES OF THE PAST

ARE IRELAND’S PUBLIC

SECTOR PAY LEVELS HIGH

BY EUROPEAN STANDARDS?

Average pay in Ireland is close to the European

average. Figure 5 illustrates that annual gross

earnings for a single person in Ireland at the average

wage equalled €34,800 in 2015, 6% below the euro

area average of €37,100. However, net earnings

were 13% above. This highlights that the income tax

burden for average and lower earnings is not actually

that high but rises sharply for higher earners.

Figure 5: Average annual gross and net earnings, single individual, no children, 100% of average

earnings in 2015

60

€000s

50

40

30

20

10

0

Luxembourg

Netherlands

Germany

Belgium

Finland

Austria

France

Euro Area

Ireland

Italy

Spain

Malta

Greece

Slovenia

Portugal

Latvia

Estonia

Slovakia

Lithuania

Gross Earnings

Source: Eurostat

Net Earnings

Unfortunately, cross-country comparisons of

public sector pay levels are rare. The most recent

comprehensive study was by the European

Commission in 2013. It found that Ireland’s publicprivate

pay gap was relatively large at 33%

compared with 10.5% on average across the euro

area. The gap between public and private sector pay

in Ireland was the sixth-largest across the euro area,

only smaller than southern European countries such

as Portugal, Cyprus, Italy and Greece.

Eurostat does provide annual earnings data for

European countries at the sectoral level. Table 3

illustrates average earnings for three sectors in

which public sector workers are located. Notably,

average earnings in Ireland’s public administration

and defence (€51,700), education (€56,300) and

health and social work (€46,400) are the highest

across the range of euro area countries in Table 3 4 .

4

These sectors may contain some private sector workers, particularly in the human health sector.

11


Table 3: Average annual earnings by sector, 2014 (€000s)

Source: Eurostat

Public administration

and defence

Education

Human health and social

work activities

Ireland €51.7 €56.3 €46.4

Netherlands €51.6 €49.4 €42.6

Belgium n.a. €47.9 €39.7

Austria n.a. €47.1 €39.6

Finland €45.8 €46.1 €38.9

Germany €42.5 €44.1 €37.7

Euro area €35.9 €36.7 €34.1

France €31.2 €35.0 €29.2

Cyprus €27.2 €34.7 €26.0

European Union €33.6 €33.4 €33.3

Italy €34.6 €31.2 €34.8

Spain €29.4 €28.4 €28.0

Portugal n.a. €24.6 €15.4

Slovenia €23.0 €22.6 €23.3

Malta €22.7 €21.4 €23.5

Estonia €15.5 €11.3 €13.4

Slovakia €12.4 €10.6 €12.3

Lithuania €10.6 €8.5 €9.0

Latvia €12.4 €8.1 €11.3

The Organisation for Economic Co-operation and

Development (OECD) provides deeper comparisons.

For example, the OECD’s ‘Education at a Glance

2016’ publication found that Irish teachers’ starting

salaries were below the OECD average. However,

after 15 years’ experience, Irish teachers’ salary

levels are significantly above the OECD average,

the sixth-highest across the countries illustrated in

Figure 6. The black dots show that the top of the

salary scale in Ireland is also among the highest in

the OECD.

“after 15 years’ experience, Irish teachers’

salary levels are significantly above the

OECD average”

12


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Figure 6: Teachers’ salaries in lower secondary education in public institutions

140 000

USD PPPs (Purchasing Power Parities)

120 000

100 000

80 000

60 000

40 000

20 000

0

Luxembourg

Germany

Salary after 15 years of experience/minimum training

Starting salary/minimum training

Source: OECD Education at a Glance, 2016

Unfortunately, the OECD’s last international

comparison of public sector pay rates including

Ireland is now quite dated (taken from its

‘Government at a Glance 2011’ publication).

Netherlands

Canada

United States

Ireland

Australia

Denmark

Japan

Belgium (Fl.)

Belgium (Fr.)

Korea

Spain

Austria

England (UK)

New Zealand

OECD average

EU22 average

Norway

Scotland (UK)

Finland

Portugal

Sweden

Slovenia

France

Mexico

Italy

Israel

Turkey

Chile

Poland

Greece

Hungary

Czech Republic

Slovak Republic

Salary at top of scale/minimum training

Nonetheless, it confirms the same pattern

– Ireland has high public sector wages by

international standards.

Table 4: Compensation of public sector employees, $000s, at purchasing power parity

Source: OECD Government at a Glance, 2011

OECD survey

average

Ireland % Difference Ireland’s position

across the survey

Medical Specialists 94.2 182.8 94.1% 1 st out of 16

Nurses 36.7 49.4 34.5% 4 th out of 19

Senior Managers (D2) 124.6 143.2 14.9% 4 th out of 21

Middle Managers (D3) 90.2 105.2 16.7% 7 th out of 22

Middle Managers (D4) 74.3 79.2 6.7% 6 th out of 18

Secretarial (a) 38.3 40.7 6.0% 10 th out of 21

Secretarial (b) 33.4 29.9 -10.3% 14 th out of 19

Economists 58.9 62.5 6.0% 6 th out of 21

Statisticians 59.9 77.6 29.5% 3 rd out 13

13


CAN WE EXPLAIN THE GAP

BETWEEN PUBLIC AND

PRIVATE SECTOR WAGES?

A common criticism of measuring the public/private

sector pay gap is that it does not compare workers

on a like-for-like basis. Some jobs such as members

of the defence forces and An Garda Síochána do

not exist in the private sector. There are also other

differences in their characteristics: public sector

workers tend to be older, have longer length of

service, are more likely to be a member of a trade

union and have a third-level degree.

Table 5: Average characteristics of public and private sector employment in Ireland

Public

Private

Age (years) 43 39

Length of service with current employer (years) 15 9

Hours worked per week 37 40

Trade union membership, % total 79% 19%

Shift Worker, % total 20% 16%

Third-level degree or higher qualification, % total 38% 23%

Source: Central Statistics Office, National Employment Survey 2010

The extent of the public/private pay gap in Ireland

has been the subject of many economic studies.

These studies aim at finding characteristics that

explain the public/private sector pay gap such as

higher education levels or qualifications among

public sector workers. The part of the 40% pay

gap that cannot be explained is referred to as the

‘underlying’ pay premium after accounting for

differences in characteristics.

Table 6: Estimates of Ireland’s public/private pay premium

Boyle, McElligot and O’Leary (2004) 13%

Murphy, Ernst and Young (2007) 10%

Kelly, McGuinness and O’Connell (2009) 26%

Foley & O’Callaghan (2009) 10%-21%

European Central Bank (2011) 19%

Central Statistics Office (2012) 6%-19%

Kelly, McGuinness and O’Connell (2012) 17%

European Commission (2013) 21%

Central Statistics Office (2017) 5%

Source: Davy

14


■ ■ ■ DAVY | ECONOMIC INSIGHTS | PUBLIC SECTOR PAY – AVOIDING THE MISTAKES OF THE PAST

Table 6 illustrates a range of estimates of the pay

premium. Some key messages from these studies are:

ππ

ππ

The pay premium enjoyed by public sector

workers grew through the Celtic Tiger period.

The ESRI has estimated that the pay premium

grew from 14% in 2003 to 26% in 2006, not

surprising as rapid pay rises occurred following

the 2002 benchmarking exercise.

The pay premium is larger for lower-paid public

servants. Figure 7 illustrates the distribution of

pay in 2010. The top 10% of income earners in

the public sector were paid €70,000 (or above),

9.5% higher than the €64,000 in the private

sector. The median public sector wage was

€42,000, 39% higher than the €30,000 in the

private sector. The bottom 10% of public sector

ππ

workers were paid €22,000, 83% higher than in

the public sector 5 . In its most recent study, the

CSO also found the underlying pay premium

ranged from 20% for the public sector workers

with the lowest pay to 5% at the median, with

highest earners actually paid 7% below their

counterparts in the private sector.

On average, the underlying public sector

wage premium is close to 20%, based on most

recent studies.

The most recent studies by the ESRI, ECB and

European Commission suggest that the pay

premium is close to 20%. We have discounted the

smaller estimates made by the CSO, including its

most recent estimate of 5%.

Figure 7: The distribution of annualised earnings across the public and private sectors

80

€000s

70

60

50

40

30

20

10

0

Bottom 10% 25th percentile Median 75th percentile Top 10%

Public Sector Private Sector Total Employment

Source: National Employment Survey 2010

“UK public sector pay levels are set almost exactly in line with the private sector despite

sharing similar characteristics to their counterparts in Ireland.”

5

The ESRI found in 2006 that senior public sector workers earned 10% more than their private sector counterparts, but lower grades earned

24-32% more.

15


This is because the CSO’s approach goes beyond

educational attainments, qualifications and

profession. The CSO’s study suggests the publicprivate

pay gap is explained by differences in trade

union membership and nationality. Hence, the

CSO’s estimates of the underlying pay premium

are lower than those of the ESRI, ECB, European

Commission and other studies that chose not to

consider trade union membership or nationality as a

determinant of pay.

Therefore our view is that, at most, only half (20%)

of the pay gap can be explained by differences in

experience, age, education and qualifications. This

is probably an upper limit. In the United Kingdom,

public sector pay levels are set almost exactly in

line with the private sector despite sharing similar

characteristics to their counterparts in Ireland.

For example, the CSO’s estimates show that on

average trade union membership is associated with

10% higher pay. Therefore, in the CSO’s methodology,

a significant proportion of the pay gap is explained

not by membership of the public sector per se, but

rather by higher levels of trade union membership

within the public sector (79%) vis-à-vis the private

sector (19%). However, this is circular logic. Trade

union membership or nationality may help explain

the pay gap but clearly cannot justify higher pay for

similar roles in the public and private sectors.

In any case, these statistical estimates of the

underlying wage premium should be taken with

a ‘pinch of salt’. They are derived from statistical

models of how wages are determined in Ireland

alone. A recent European Commission paper takes

a broader view, finding that wages in Ireland were

exceptionally high compared with other European

countries even after accounting for differences in

workers’ characteristics. Furthermore, the European

Commission found that the pay premium of 20% in

Ireland was the largest across 26 European countries.

16


■ ■ ■ DAVY | ECONOMIC INSIGHTS | PUBLIC SECTOR PAY – AVOIDING THE MISTAKES OF THE PAST

HOW SHOULD WE

VALUE IRISH PUBLIC

SECTOR PENSIONS?

The PSPC report will consider the value of public

sector pensions. The equivalent market value of

such defined benefit pensions has soared over the

past 10 years as annuity rates have fallen. Figure

8 illustrates that the annuity rate for a single male

aged 65 years to buy a fixed income of €10,000 per

annum fell from 7% at the beginning of 2008 to 4.1%

at the start of 2016 6 . The market value of such an

annuity has soared from €143,000 to €245,000.

The fall in annuity rates has reflected both historically

low interest rates but also improvements in life

expectancy. Interest rates will rise when the Federal

Reserve and ECB eventually tighten their monetary

policies. However, life expectancy will continue

improving. So annuity rates are unlikely to rise back

to levels seen 10 years ago. Put simply, public sector

pensions are now worth more because they will

provide a defined income over a longer period.

Figure 8: Annuity rates and capital values for single male, 65-years, €10,000 p.a.

8.0%

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

€280,000

€260,000

€240,000

€220,000

€200,000

€180,000

€160,000

€140,000

€120,000

0.0%

€100,000

2008 2009 2010 2011 2012 2013 2014 2015 2016

Market Value Annuity Rate

Source: Davy; Factset

In Table 7 we illustrate that the current annuity

rate for an index-linked pension for a 65-year-old

male is 2.18% (with a 50% reversionary pension to

the spouse). We have chosen this annuity rate as it

most closely matches public sector defined benefit

pensions. Under the career average salary scheme,

new recruits to the public sector are entitled to a

pension that, combined with the contributory Pay

Related Social Insurance (PRSI) pension, provides

them with 50% of their average income.

Average public sector earnings currently equal

€47,400 and the contributory pension provides

€12,390 of annual income. Hence, the average

public sector pension for 40 years’ service would

provide an additional €11,300 of income per annum.

At current annuity rates, buying such a pension

(together with the lump sum payment) would cost

€590,000. If annuity rates rose to 3.27%, the capital

value would fall to €416,600.

6

This annuity rate is for a non-index lined pension so the capital value cannot be directly compared to an equivalent defined benefit public

sector pension.

17


The contributions to achieve such a pension pot

depend on the expected rates of return. Table 7

shows optimistic, base and pessimistic scenarios

where rates of return vary from 3%, 4% and 5%. Here

the required annual contribution varies from €7,600

to €3,300. At current annuity rates, the required

annual contribution would be equivalent to 10-16%

of average public sector pay.

Table 7: Market value and contributions to match average public sector pensions

Required annual gross contribution over 40 years

Annuity rates Capitalised value 3% return p.a. 4% return p.a. 5% return p.a.

Current market rate, 2.18% €589,358 €7,589 €5,964 €4,646

Higher rate, 3.27% €416,606 €5,364 €4,216 €3,285

Source: Davy calculations

However, these calculations are extremely simplistic.

The majority of existing public servants are still

entitled to pensions linked to their final salary rather

than the average salary. In these cases, it is pay at

the end of their career that is relevant, well above

the average of €47,400 illustrated above. Also, many

public sector pensions are linked to public sector

wages, which we would expect to grow faster on

average than CPI (Consumer Price Index) inflation.

Taking this benefit fully into account would increase

the capitalised value of their pensions.

In addition, because the public sector pension takes

into account a fixed level of income the value of

pension benefits rises sharply for public servants

who have pay levels above the average. For example,

a salary of €47,400 results in a pension of €11,300;

however, a salary of €75,000 would result in a

pension of €25,100. Effectively, a c.60% higher salary

results in a c.120% higher pension. At current annuity

rates, a pension that provided €25,000 of income per

annum would cost significantly in excess of €1 million.

Many public sector workers also have the option to

retire on full benefits from age 60 (or earlier for some

workers) or the ability to buy extra service at very

generous rates.

Of course, these estimates need to be seen in the

context of the pension levy imposed on public

servants who, like private sector workers, are asked

to contribute to their pensions. Finally, public sector

pensions are free of the risks facing employees in

defined contribution schemes. Those left in private

defined benefit schemes also face the threat of

wind-up if they run unsustainable deficits.

In summary, while valuing public sector pensions is

highly complex, their worth is certainly far in excess

of the contribution from the employee – particularly

for average and higher earners – and should be

taken into account by the PSPC.

“The majority of existing public servants

are still entitled to pensions linked to their

final salary rather than the average salary”

18


■ ■ ■ DAVY | ECONOMIC INSIGHTS | PUBLIC SECTOR PAY – AVOIDING THE MISTAKES OF THE PAST

A MORE FLEXIBLE FORM

OF PAY BARGAINING

A bigger issue is whether centralised wage

agreements are the best way to set public sector

pay. Having adopted the euro, the Irish government

is left with limited tools with which to stabilise the

Irish economy. This was most evident during the

EU/IMF (International Monetary Fund) programme,

when difficult sharp fiscal adjustments were

implemented during the depth of the recession.

However, the seeds of the bust were sown by

overly exuberant public and private sector pay

increases. As the recession unfolded, too much of

the adjustment took the form of jobs cuts with less

severe reductions in pay.

It would be disappointing to see the mistakes of

the past repeated. Once again, a perception has

formed that the economic recovery has left public

sector pay behind. However, the economy now faces

the uncertainty of Brexit, and questions remain

on the sustainability of the corporate tax revenue

base. As in the Celtic Tiger era, it would be highly

irresponsible to predicate multi-year pay increases

on unstable tax revenues.

In this context, a more flexible form of wage

bargaining may be warranted. Such proposals have

been made in the past. For example, MacCoille and

McCoy (2001) argued that Ireland’s centralised wage

bargaining mechanism needed modification. They

identified two flaws. First, agreements for multiyear

wage increases did not reflect the uncertain

outlook for the Irish economy. Second, Social

Partnership did not provide a means to cope with an

overheating economy.

Others have argued for a more flexible approach.

Donal De Buitléir and Don Thornhill (2001)

advocated a gain sharing arrangement based on the

economic outcomes, essentially envisaging a form

of ‘profit sharing’ in public sector pay agreements.

Similarly, John McHale (2001) advocated the use of

deferred compensation mechanisms within Social

Partnership. More recently, the Department of

Finance has expressed a preference that the wage

setting process should be as flexible as possible to

maintain competitiveness and growth. Given the

risks facing the economy from Brexit, it may now be

time to reconsider proposals for a more flexible form

of public sector pay bargaining.

There is also a question on whether centralised

wage agreements for the public sector are

appropriate. In the UK, there are separate processes

for different parts of the public sector – which may

help prevent inappropriate ‘relativities’ between

sectors imposing an additional rigidity on pay.

“Given the risks facing the economy from

Brexit, it may now be time to reconsider

proposals for a more flexible form of

public sector pay bargaining”

19


IMPORTANT

DISCLOSURES

Analyst certification

I, Conall Mac Coille, hereby certify that: (1) the

views expressed in this research report accurately

reflect my personal views about any or all of the

subject securities or issuers referred to in this report

and (2) no part of my compensation was, is or will

be, directly or indirectly, related to the specific

recommendation or views expressed in this report.

Investment ratings

A summary of existing and previous ratings for

each company under coverage, together with an

indication of which of these companies Davy has

provided investment banking services to, is available

at www.davy.ie/ratings.

Investment ratings definitions

Davy ratings are indicators of the expected

performance of the stock relative to its sector index

(FTSE E300) over the next 12 months. At times,

the performance might fall outside the general

ranges stated below due to near-term events,

market conditions, stock volatility or – in some

cases – company-specific issues. Research reports

and ratings should not be relied upon as individual

investment advice. As always, an investor’s decision

to buy or sell a security must depend on individual

circumstances, including existing holdings, time

horizons and risk tolerance.

Our ratings are based on the following parameters:

Outperform: Outperforms the relevant E300 sector

by 10% or more over the next 12 months.

Neutral: Performs in-line with the relevant E300

sector (+/-10%) over the next 12 months.

Underperform: Underperforms the relevant E300

sector by 10% or more over the next 12 months.

Under Review: Rating is actively under review.

Suspended: Rating is suspended until further notice.

Restricted: The rating has been removed in

accordance with Davy policy and/or applicable

law and regulations where Davy is engaged in an

investment banking transaction and in certain other

circumstances.

Distribution of ratings/investment banking relationships

Investment banking services /

Past 12 months

Rating Count Percent Count Percent

Outperform 71 53 29 74

Neutral 38 28 4 10

Underperform 12 9 0 0

Under Review 3 2 2 5

Suspended 5 3 0 0

Restricted 4 3 4 10

Source: Davy calculations

20

This is a summary of Davy ratings for all companies

under research coverage, including those companies

under coverage to which Davy has provided material

investment banking services in the previous 12

months. This summary is updated on a quarterly

basis. The term ‘material investment banking

services’ includes Davy acting as broker as well as

the provision of corporate finance services, such

as underwriting and managing or advising on a

public offer.


■ ■ ■ DAVY | ECONOMIC INSIGHTS | PUBLIC SECTOR PAY – AVOIDING THE MISTAKES OF THE PAST

REGULATORY AND OTHER

IMPORTANT INFORMATION

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21


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We are satisfied that our internal policy on share

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Confidential © Davy 2017.

Other important disclosures

This report was completed at 5pm GMT on March

24 2017. It was issued at 8am GMT on March 27

2017.

US Securities Exchange Act, 1934

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shall not distribute or provide this report, or any part

thereof, to any other person.

22


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