Treasury advice challenging basis for fair pay agreements ignored

Dr Eric Crampton
The National Business Review
28 September, 2018

Fair risks?

Well, the government won’t be able to say it wasn’t warned about the risks in its fair pay agreements process.

The Treasury last week released its advice on the government’s May cabinet paper that proposed fair pay agreements. The advice is good, thorough and blunt. We should all pay attention to it even if the cabinet did not.

Policy processes are supposed to start with an adequate problem definition. The ministries spell out what really needs to be fixed before canvassing options for addressing the identified problem. The proposed policies should have at least some connection to the identified problem.

Election policies too easily work the other way, with politicians scrambling to find a problem that might justify the policy they’d proposed. In my previous life as an academic, I even received an email from a UK bureaucrat asking which market failure theory might help justify the policy intervention his minister wished to run. I tried to explain that the policy process should not work that way but I doubt it did much good.

The cabinet paper proposing the Fair Pay Working Group pointed to labour market problems, including poor productivity growth, poor wage growth and a declining labour income share. It suggested monopsony problems could lead to a race to the bottom. And so it proposed industry- or occupation-wide Fair Pay Agreements as a solution.

The Treasury’s advice began by questioning whether imbalances in bargaining power really lie at the root of wage and productivity concerns, as the cabinet paper provided no empirical evidence making the case.

Most effective way to deal with it?

Even if bargaining power were the problem, the Treasury argued there is no strong case that industry- or occupation-level bargaining would be the most effective way of dealing with it. It also reminded the cabinet that the Ministry of Business’ initial work had failed to identify an occupation or industry where a fair pay award might fix anything.

In the absence of any demonstrable link between the high-level problem around wages and productivity, and the paper’s suggested cause of bargaining power imbalances, we can wonder whether the problem definition in the cabinet paper was simply backfill to justify a policy that Labour wanted to implement for other reasons.

This would be a poor but too common practice for minor policies. But it is especially dangerous in areas with broad consequences.

Treasury warned that the government’s proposed Fair Pay Working Group is a risky way of setting policy: “This policy process requires the working group to make complex policy judgments with only a high-level diagnosis of the problem and limited policy guidance from the cabinet, and at some distance from related policy activity. These judgments could in turn make substantial structural changes to the labour market …”

It then cited OECD work showing the difficulties in reforming collective bargaining systems, the unpredictability of even well-crafted reforms, and the risks to those left out of the system. The interests of workers with jobs covered by agreements are not always the same as the interests of those trying to find work. Rigid bargaining systems can easily disadvantage lower-skilled workers. They can also easily disadvantage smaller firms less able to bear the system’s costs and have anti-competitive consequences. And they bake in fragility against changing conditions. The Treasury cited research on the Great Recession showing it is harder for firms to remain competitive if they fall under centralised bargaining rather than being able to adapt to their own conditions – with layoffs and reduced profits as consequences.

More time needed

Finally, the Treasury warned the process could harm the regions. At present employers and employees can bargain to conditions that suit local circumstances. Centralised bargaining can remove that important flexibility.

Given the risks of rather bad consequences extending across entire industries, the Treasury recommended giving the bureaux more time to scope things out and restore the normal policy process of properly identifying the causes of problems and the range of effective options. It also wanted time to assess what makes for more successful industry-wide or occupation-wide bargaining structures. All of that could then have fed into the working group’s terms of reference.

The Treasury’s advice was provided on May 3 for the May 17 lodging of the cabinet paper. Minister Iain Lees-Galloway announced the Fair Pay Agreement Working Group on June 5. The Treasury’s warnings seem to have fallen on deaf ears.

A pessimist could read this as failure. But that is missing the bigger picture. The New Zealand civil service has to be able to provide free and frank advice, especially advice that is unwelcome. The Treasury has pulled many punches but not this time. The advice cannot have been welcome as it suggests a key government initiative rests on highly unstable foundations and risks imposing a substantial cost to the country.

But the Treasury provided it anyway.

And with the release of the Treasury’s advice, we can all benefit.

Governments cannot and should not be bound to follow the advice of their officials. Sometimes officials are wrong, and sometimes politics requires trade-offs across a broader range of considerations.

We should think of released ministry advice as providing transparency. We now all know that the Treasury has warned against this approach.

A government implementing bad policy that was nevertheless in keeping with the best advice available at the time should be given some slack. Not all failures are foreseeable, and there is too much risk aversion in policy.

But a government that proceeds despite the best advice available is in a different position. Advice not heeded has its own value. It lets us all know that the government should have known better.

Dr Crampton is chief economist with The New Zealand Initiative.

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