Guardian economics…..

Putting the direct costs of the pay cap to public services aside, there is also the so-called multiplier effect to consider. This means when you give someone a pay rise, there are larger positive implications for the economy because it can stimulate further rounds of spending. For example, if there is a £2bn increase in wages for NHS workers and they spend just half of this in shops, then shopkeepers will also receive income.

In turn, this increase in income will mean shopkeepers are more likely to employ more people and increase salaries themselves. The treasury would then not just receive more taxes from higher wages among NHS staff, but also the VAT on extra goods sold, and on higher income taxes from jobs created elsewhere.

The multiplier effect is thought to be higher for those on low-middle incomes, as they are much more likely to spend it than save it or put it in a tax haven. According to a Unison study based on International Monetary Fund figures, every 1% increase in public sector pay would generate between £710m and £820m for the government in increased income tax. Of course, there are debates about just how big these multiplier effects are – but we must stop thinking about a pay rise as purely negative for the public purse. We all know that our public service workers are worth every penny – but these pennies go well beyond their pay packets.

It’s not economics unless you consider opportunity costs. That money has come from someone. Might be tax, might be borrowing, but those who had it would have also spent some portion of it into the economy. Even if we say that borrowing means it is obviously only coming from savings if those savings weren’t put into gilts then it would have been invested elsewhere instead.

What we actually want to know is what is the effect after this? This is known as the marginal propensity to spend (or save, the inverse). If we take tax off low paid people and give it to low paid people then the net effect is nothing. Because whatever the marginal propensity to spend of the poor is, it’ll be the same or those who lose money as those who gain it. If we take money off the rich then there will be a change. But that change is not the amount of money itself. It’s the difference between what the rich would have spent and the poor do spend. A useful rule ot thumb here is some 15%. Upper middle classes might save 15% of any marginal income, the poor 0%, that’s the amount that spending rises by.

Do also note that this only applies to tax funded increases in such wages. If it’s from what is already being saved well, those savings would have been used to invest in some other thing if not borrowed by government.

The argument is true but it’s a very, very, weak one, with nothing like the power attributed to it.

22 thoughts on “Guardian economics…..”

  1. I’m no economist, but also: inflation destroying the ‘value’ of the extra money? In fact surely the multiplier effect is cancelled by inflation (to some extent). As I say, I’m no economist by a looong shot, but surely that has to be taken into account too?

  2. Sure, there’re all sorts of other things to take into account. Inflation, is the public sector more efficient than private and so on. Economies are complex things. But this specific piece of this specific argument works as I say.

  3. If Polly wants to argue that there is some multiplier effect on increasing the incomes of people on lower incomes she can do that. It is true, though as per TW her math is wrong. To me that suggests she should want to cut taxes for those on low incomes thus benefiting all those on low incomes. I don’t see how her argument supports paying more to public sector employees – many of whom are not on low incomes, even more so once the generous employment terms and pension benefits are considered.

  4. The government have been in reaction mode badly over this issue. Yes Public sector are going to say to their unions– do your job and get me more pay. Unions will get some demos and media coverage as a prelude to strikes. Media will report there is “growing pressure” on May. Eventually someone cracks. But hold on Tim tells us the private sector pay has not been rising either. So where is the counter, the very strong counter, which shouldn’t even be a counter it should be a very strong pre-emptor that “no-one gets a pay rise till everybody does”

  5. @Tomsmith – the left don’t understand the concept of reducing taxes… That gives power to the people, which, although they say they want to do that, what they actually want to do is tell you how to do things…

  6. A pay increase is not even increased productivity.

    So – in effect – are we taking money out of the private sector, putting it into the public sector, and not even for a productivity increase?

    Wouldn’t that be destroying wealth (production) – or did I miss a crucial bit?

  7. As the public sector are already paid more than the private sector, surely the multiplier effect will be negative because the money to give a pay rise to the public sector workers is being taken from poorer people who would otherwise be *more* likely to spend it?
    Taking money from the rich to give to the poor stimulates the economy – taking money from the poor to give to the rich should dampen it down.

  8. John77 (and Hallowed Be); yup, the ONS Average Weekly Earnings numbers so a ~£40 public sector wage premium. Been higher (~£50 a couple of years ago), but seems to have had that premium since the time series began in 2000. Odd that.

    (I’m assuming that they’re cash wages, not total comp, but not entirely sure).

    Thing is, normally, a pay and hiring freeze would shrink yer actual wage bill over a couple of years, but with that sort of premium, and effectively high employment, that would take considerably longer to work through, in the absence of other stuff happening. Theresa May’s Team are cocking this one right up.

  9. “We all know that our public service workers are worth every penny”: oh do fuck off. Some are. Many aren’t, not least because their jobs shouldn’t exist in the first place. I blame that Gordon Brown and many others.

  10. @Dearie me

    That sentence struck me too. It reminded me of the way that praesidium discussions always acknowledged the ghost of Lenin at the table.

  11. “We all know that our public service workers are worth every penny”: oh do fuck off. Some are. Many aren’t

    I’m back contracting to the public sector for half a week. It is the only place I have ever met people who are _proud_ to be doing their job badly. And doing it maliciously badly as well, in the worst cases.

  12. If the multiplier is such a certain thing, why hasn’t a deficit of £100 billion cured the economy? Furthermore, the savings which are being reduced are not just kept under the bed, but are being lent or invested. To reduce that will surely distort investment and reduce growth.

  13. Note that the 1% pay rise cap doesn’t include the standard annual increments until the public sector worker reaches the top of their pay scale. So not really a 1% cap at all.

    What is never mentioned is just how much of public sector pay is sent back to the employees home countries.

  14. ‘Employers pay what they have to pay to attract and retain people who can do what they want done.’ – GC

    There is no reason to pay government workers more. NONE!

    But if this effect were real, you could still do it. Dump a million pounds in Piccadilly every day. Wait . . . Wembley Stadium. Sell tickets! Nightly news can show the day’s rush for cash.

    It’s the spending that counts, not who spends it! So let whoever can grab it have it.

    ‘If you want it, here it is come and get it
    Mmmm, make your mind up fast’

  15. The G doesn’t understand effects at the margin – the person earning 20k selling making felt whisky bottles to sell to tourists might decide to jack it in and earn 21k working for the council taking people to court for unpaid taxes.

  16. @Hallowed Be, September 19, 2017 at 10:15 am

    …But hold on Tim tells us the private sector pay has not been rising either. So where is the counter, the very strong counter, which shouldn’t even be a counter it should be a very strong pre-emptor that “no-one gets a pay rise till everybody does”

    In UK Politicians the counter is mostly the lone – but strong – voice of Jacob Rees-Mogg

  17. Street Sparrow,

    “Increments” went for many public sector roles, lots of years ago: some areas never had them at all. The military still get them, I think the NHS do, not sure about some others; civilian MoD and trading funds lost them seven or eight years ago.

    But, nobody cares about defence compared to the Great God Skoolzanospitals… which is why you see new sociology graduates dropped into buying £350 million of artillery for the Army, and then everyone acts surprised that it went badly wrong…

  18. ‘Demand for commodities is not demand for labour”

    J S Mill


    ‘John Stuart Mill’s profound insight that demand for commodities is not demand for labor, which Leslie Stephen could in 1878 still describe as the doctrine whose “complete apprehension is, perhaps, the best test of a sound economist,” remained for Keynes an incomprehensible absurdity’ (Collected Works, vol. 9., p. 249).

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