Public sector pay and inflation – the implications for the Welsh budget and public services

Last week saw the publication of pay recommendations by the NHS Pay Review Body and the Independent Welsh Pay Review Body.

The recommendations made − and accepted by the Welsh Government − represent real-term pay cuts for workers, raising the prospect of industrial action across the public sector.

Meanwhile, the lack of additional funding to pay for higher-than-expected pay increases will have serious implications for the delivery of public services.

This blog post sets out our analysis of the costs and implications of the recommended pay deals in the context of the fiscal outlook for the Welsh budget.

The fiscal context

By increasing day-to-day spending relative to March 2021 plans, the UK government argued the 2021 Spending Review delivered “the largest annual funding settlement to Wales since devolution”. Core funding for day-to-day Welsh Government spending (excluding one-off Covid-19 funding) would grow by around £2 billion from 2021-22 to 2022-23, and by £2.9 billion to 2024-25.

However, the block grant settlement was announced in cash terms back in October, when inflation was set to peak at around 4 per cent. Inflation is now expected to peak at 11 per cent and remain elevated for longer. In real terms, the UK government’s claim of an exceptionally generous settlement no longer rings true.

As an illustration, when the Welsh Government set its multi-year budget plans in December, total allocations for day-to-day department spending were expected to increase by an average of 3.3% a year in real terms from 2021-22 to 2024-25 (with the increase front-loaded in 2022-23). Higher inflation could wipe out around a half of that projected real terms increase. By 2024-25, it could require up to a £1 billion of additional funding to restore spending power to its initially projected level.[1]

The overall inflationary pressures faced by public services is greatly affected by pay settlements from year to year. One response to the austerity of the last decade was to hold down public sector pay.

While economy-wide earnings growth has been exceptionally poor since the financial crisis, public sector average pay has trailed the private sector since 2010-11 (as seen in Figure 1).

Although there has been some protection and pay increases for those at the bottom of the pay distribution (workers in 10^th percentile shown in Figure 1), pay cuts have particularly hit higher-paid and more experienced public sector workers.

Figure 1: Real term (CPIH-adjusted) trends in Welsh gross weekly pay since 2010-11

Source: ONS (2021 and previous) Annual Survey of Hours and Earnings – Table 25.

NHS pay

Last week, the Welsh Government accepted the NHS Pay Review Body recommendation of a £1,400 pay rise for NHS staff on most pay grades – equating to 4%-5.5% for most NHS staff. Following the real living wage pay rise announced back in April, pay for the lowest-paid staff will increase by 10.8%, and will average 7.5% for staff across bands 1 to 4 (just under a half of all ‘Agenda for Pay’ staff).

The Welsh Government also accepted the recommendations of the Doctors’ and Dentists’ Review Body for a 4.5% pay increase.

These pay rises are generally well below the rate of inflation, which reached 9.4% in the year to June. As a result, the Royal College of Nursing in Wales have said they will ballot members on whether to take industrial action, while the British Medical Association described it as a “kick in the teeth”.

At the same time, the pay rises appear to be above what was budgeted for when the UK government set out its spending plans at the Spending Review.

Using our model of the NHS pay bill in Wales, we estimate the pay increase will cost around £231 million above keeping current pay scales.[2] If the Welsh Government were expecting a 2-3% average pay rise (in line with initial UK government assumptions), the pay recommendation roughly amounts to an additional £100 million next year.

In addition, if we assume the NHS workforce continues to grow in line with recent trends, alongside increased employer costs from the Health and Social Care Levy, we estimate the total Welsh NHS pay bill could grow by £426 million from 2021-22 to 2022-23.

To put this in context, that would amount to just under half the £912 million increase in core NHS day-to-day spending allocated in Welsh budget plans.

Although the level of inflation is expected to peak this year, the budgetary outlook is set to deteriorate further in following years, with only very limited nominal terms growth.

In Figure 2 below, we model the increase in NHS staff and employment costs with the recommended pay deal for 2022-23, followed by CPI-matching increases for all staff in 2023-24 and 2024-25.

Figure 2: Modelled increase in total NHS staff and employment costs and budgeted increase in NHS spending from 2021-22 baseline

Source: Wales Fiscal Analysis modelling

In this scenario, the increase in the NHS pay bill would eat up over four-fifths of the total increase in NHS spending by 2024-25. These pay pressures would come over years in which there are huge demands for increased service provision to deal with the legacy of Covid-19.

This outlook therefore suggests NHS workers could be facing further real terms pay cuts after this year unless current spending plans are topped up. Alternatively, the NHS would need to respond by cutting its headcount, other budgets, or curtail its ambitions to clear the backlog over coming years.

Other public sector workers

The latest pay deal for Welsh teachers was also announced last week.

The Welsh Government accepted the Independent Welsh Pay Review Body’s recommended pay uplifts for the teaching workforce. Teachers will receive a 5% raise for the 2022-23 academic year and a further 3.5% pay uplift for 2023-24, subject to economic conditions – a caveat reflecting the continued uncertainty around the inflation rate’s future trajectory.

We estimate these pay awards will cost £76 million in 2022-23 and a further £52 million in the following academic year – costs that could need to be met from the existing three-year local government settlement.

A long-running commitment to increase starting salaries for new teachers in England to £30,000 is now set to be met by September 2023 in both England and Wales.

Although pay awards for the non-teaching local government workforce continue to be decided on an England and Wales basis, devolved policymaking is increasingly having an impact on the pay bill in this area as well. An ongoing commitment to uplift minimum pay rates in line with the cost-of-living-indexed Real Living Wage now applies to the 65,000-strong care workforce in Wales. The Real Living Wage is expected to rise by a record amount later this year, increasing both the employee costs of social services departments as well as payments to commissioned providers. Nevertheless, the continuing prevalence of low pay and poor terms and conditions in the sector suggests that addressing this is rightly a government priority.

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The Welsh Government has some room for manoeuvre this year to accommodate the higher-than-expected pay deals. It has £152 million of ‘unallocated’ day-to-day spending for 2022-23 in its latest spending plans, as well as the possibility of drawing-down more funding from the Wales Reserve (up to £92 million).

However, the budget outlook looks set to deteriorate further over coming years. That could lead to further pay cuts for public sector workers, extensive industrial action, significant recruitment and retention issues, cuts to non-pay budgets, and a further deterioration in the range and quality of public services.

Once again, the Welsh Government will wait to see if the UK government tops up its spending plans later this year, a decision that’s been left to the new occupants of Numbers 10 and 11 Downing Street. Given the tone of debates to date, there appears little prospect of any candidate prioritising public spending over tax cuts.

[1] Whereas it is customary to use the GDP deflator measure of inflation to deflate public spending totals, this analysis uses the CPI measure of inflation (OBR March 2022 forecast), given the GDP deflator series is still impacted by the effect of the Covid-19 pandemic and is not projected to increase as much as other measures.

[2] Information on our modelling of NHS pay pressures can be found here.