Market-facing pay in the public sector: the role of the pay review bodies

This article looks at the work the independent review bodies have been asked by the Chancellor to carry out into how public-sector pay might be made more responsive to local labour markets, and examines the issues involved in moving to "market-facing" pay in the public sector.

Since the Government announced its intention to make public-sector pay more responsive to local labour markets to "create a more balanced economy in the regions of our country that does not squeeze out the private sector", there has been debate about the extent of the public-sector "pay premium" and whether a move to more local pay-setting would damage rather than boost local economies. The independent public-sector pay review bodies have been asked to consider how pay might be made more market-facing for their remit groups. We look at some of the evidence they have gathered for this task, and find that, while trade unions and the devolved administrations are opposed to regional pay, there also seems to be resistance to a wholesale move away from national systems on the part of public-sector employers, which favour a system of national structures with increased local flexibility.

In a recent article, XpertHR looked at the recommendations on pay awards for 2012 by the independent public-sector pay review bodies. The six review bodies make recommendations on pay for around 2.5 million employees, including schoolteachers, NHS workers, the armed forces and prison officers.

The review bodies have different geographical coverage across the UK: for example, while the School Teachers' Review Body (STRB) covers teachers in England and Wales, Scotland has separate arrangements for determining pay for its schoolteachers. Similarly, pay is agreed by negotiation for the Scottish Prison Service. The Prison Service Pay Review Body (PSPRB) makes recommendations covering England and Wales, and produces a separate report for Northern Ireland. Although the NHS Pay Review Body and the Review Body on Doctors' and Dentists' Remuneration cover staff across the UK, remits to the review bodies and decisions on their recommendations are made by the health ministers in the devolved administrations.

The pay review bodies will play a central role in the Government's future public-sector pay strategy. In his 2011 autumn statement, George Osborne made two announcements that affected the review bodies' remit groups:

• following the two-year public-sector pay freeze, pay awards would average 1% for two years; and
• the pay review bodies would be asked to consider how public-sector pay might be made more responsive to local labour markets, to report by July 2012. This would apply to all pay review body workforces, with the exception of doctors, dentists, the armed forces and the judiciary.

The autumn statement also announced that the Minister for the Cabinet Office would review how more local, market-facing pay might be introduced in civil service departments.

Review bodies set task of looking at market-facing pay

In December 2011, the Chancellor wrote to the review bodies to set out further details of their role.

He explained that, following his announcement that the Government would seek pay awards that average 1% for the two years after the pay freeze, the review bodies would receive remit letters in advance of the 2013/14 pay round in line with the normal process. He continued: "However, when it comes to setting pay policy after the freeze, the Government is concerned not only with the appropriate annual uplift, but also ensuring that overall public-sector pay systems are the most appropriate for the modern labour market."

His letter said: "... there is substantial evidence that the differential between public- and private-sector wages varies considerably between local labour markets. This has the potential to hurt private-sector businesses that need to compete with higher public-sector wages; lead to unfair variations in public-sector service quality; and reduce the number of jobs that the public sector can support for any given level of expenditure.

"The Government believes that there is a clear case for seeking to correct these problems, ensuring that public-sector pay does not distort local markets."

He confirmed that the armed forces, the judiciary and the senior military were excluded from the process, while "doctors and dentists have currently been excluded".

The Chancellor asked the four review bodies covering the remaining groups - NHS workers covered by the Agenda for Change agreement and "very senior NHS managers" in England, schoolteachers and prison staff in England and Wales, and the senior civil service in Great Britain - to "consider how to make pay more market-facing in local areas" for the staff within their remit groups. As well as the need to recruit, retain and motivate suitably able and qualified staff, he said that they should take into account the following factors:

• the difference in total reward between staff in their remit groups and those of similar skills working in the private sector, by location, and the impact of these differences on local labour markets;
• how private-sector employers determine wages for staff in different areas of the country;
• what the most appropriate areas or zones by which to differentiate pay levels might be;
• the affordability of any proposals - which he stressed should not lead to any increase in the paybill in the short or long term;
• the need to ensure proposals are consistent with the law on equal pay;
• whether or not, and if so how, the new approach could be delivered within national frameworks; and
• whether the proposals should apply to existing staff or just to new entrants.

The Chancellor asked for initial findings by 17 July 2012, so they could feed into the 2013/14 pay round. The letters from the Chancellor were followed by further details from the secretaries of state and ministers setting out the approach the review bodies should take for their remit groups.

Call for evidence

In January 2012, the Office of Manpower Economics, which provides the secretariat for the review bodies, put out a call for evidence on how to make pay more market-facing. In particular, it requested:

• examples of where private-sector employers have had difficulty in recruiting or retaining staff as a result of competition from the employers of the review body groups included in the review;
• examples of where public-sector employers of these groups have had difficulty in recruiting or retaining staff as a result of competition from wider public- or private-sector employers;
• research or evidence on comparative levels of public- and private-sector pay - or total reward - in specific areas or regions or for specific occupations or jobs; and
• information on how larger private-sector employers operating in multiple locations decide on appropriate levels of reward for these locations.

It also said it would welcome information about how private-sector employers set pay in different localities and what factors they take into account.

The evidence provided has been made available to the four review bodies with remits to look at market-facing pay and published on the OME website. Respondents include the TUC, the Institute of Directors, the Local Government Association and the CBI.

The call for evidence went out before the letters from departments giving further detail on senior civil servants and schoolteachers had been issued. It stated that the review bodies with remits to look at local pay would be contacting the relevant government departments, employer organisations and trade unions with specific requests for evidence.

In his March 2012 Budget, the Chancellor announced that the Treasury's evidence to the review bodies was being published. This evidence states that: "The existence of pay premia suggests that the public sector pays more than is necessary to recruit, retain and motivate staff in some areas... In places where private-sector firms have to compete for workers with public-sector employers offering a large pay premium, the introduction of more local, market-facing pay could help private businesses, particularly in some sectors, become more competitive and expand." The evidence also confirms that changes would need to be "implemented in a way that is appropriate for each individual workforce". It put forward the Ministry of Justice local-pay model for courts-service staff as an example of market-facing pay within a national bargaining structure that has been introduced successfully in the public sector.

The Budget document confirmed that civil service departments exiting the pay freeze in 2012 will be able to introduce market-facing pay reform from this year. Further details of this process are set out in the Civil Service Pay Guidance issued in March 2012.

Reaction from trade unions and business organisations

Perhaps unsurprisingly, trade unions and employers' organisations are split on the issue of market-facing pay.

In response to the OME's call for evidence, the TUC submitted a document, drafted with input from its affiliated unions with members in the public sector, that considered issues of relevance to the public sector as a whole. It concluded that the evidence did not support the case for regional or local pay in the public sector, raising concerns that included: undoing the progress made in establishing equal pay; the increased resources involved in moving from national pay bargaining to local pay-setting; and the impact on local economies of cutting public-sector pay. It said: "A major concern about introducing local or regional pay in the public sector is that it is highly likely to be counterproductive, acting to dampen economic growth and increase regional disparities... The idea that the private sector is being 'squeezed out' as a result of an inability to match public-sector wages is not credible, particularly in the current economic context."

The TUC expressed the view that there was "patchy evidence as to what extent clear local and regional labour markets exist, and this is especially true in the occupations covered by the pay review bodies.

"Outside London and the South-East of England, there is little difference in earnings between regions. Regions tend not to have homogenous labour markets, but to have pay 'hotspots' within regions, where skill shortages lead to higher pay.

"Rather than geography, the main determinants of pay levels are skill level and qualification level."

The National Union of Teachers (NUT) has vowed to challenge Government attempts to introduce regional pay. Christine Blower, the union's general secretary, said: "The NUT is completely opposed to the Government's plan to attack national pay and conditions arrangements for teachers. Our headteacher members are only too well aware of how difficult it would be to establish their own pay system for their school. Not only would it take an inordinate amount of time, local pay bargaining in some 25,000 separate schools would create unnecessary bureaucracy, complexity, cost and potential inequity."

The Association of Teachers and Lecturers (ATL) described the prospect of schools devising their own pay scales as "lunacy". Mary Bousted, ATL general secretary, said: "We want to retain a national pay system, because it is what works best for schools and teachers in the UK. We have yet to see any evidence that any other system would work as well. If regional pay is introduced school by school, with a complete break-up of national pay, then that could be a focus of industrial action by the union."

At Unison's health conference, the union's general secretary Dave Prentis said: "We will not sit back and allow Andrew Lansley, the Secretary of State for Health, to destroy our national pay agreement. If he tries to undermine Agenda for Change, if he tries to reduce the pay of our members who live and work in poorer communities, if the unjust and unfair pay freeze does not end - we will make our stand."

The unions have also set out their case in evidence to the individual review bodies.

The Prospect union described the Government's evidence to the pay review bodies as "flimsy and ill-thought through", saying that the figures do not properly reflect the make-up of the labour market and its private-sector comparators in each region. It has warned that linking public-sector pay more closely to local labour markets is "a tired old rehash of ideas that didn't work in the 1990s and certainly won't work now".

The PCS union described the Chancellor's desire to move to local pay-setting in the public sector as "economically incoherent". It said: "This proposal is unfair as it is an attempt to break apart existing national bargaining structures across the public sector. In the civil service, where pay bargaining is delegated to separate departments, agencies and other bodies, most of which set pay rates for the country as a whole, local pay threatens to cut pay values for the vast majority of PCS members."

In contrast, evidence from the CBI states that: "Freedom to set pay rates at a genuinely local level is also necessary to truly allow public-sector pay structures to respond to fluctuating recruitment and retention flows... Moving away from a one-size-fits-all approach will reduce the deadweight costs of unnecessarily high-cost public-sector pay." However, it acknowledges that the transition from national to localised pay bargaining will be a gradual process that is "necessary for long-term economic rebalancing and taxpayer value, rather than to generate immediate cost savings".

The Institute of Directors' (IOD) evidence presented the findings of a survey of more than 1,000 of its members. Although 57% of respondents said that they would support decentralising public-sector pay in health and education, exactly the same proportion said that they had never experienced a problem with national public-sector pay scales making it difficult for small and medium-sized enterprises to attract skilled staff because they could not compete on wage levels. The IoD concluded that it was in favour of making public-sector pay more market-facing in local areas for certain groups of workers, as it believed this would be likely to lead to increased levels of private-sector employment, especially outside London and the South-East.

Review Body on Senior Salaries

Andrew Lansley confirmed the remit for the Review Body on Senior Salaries (SSRB) in respect of very senior NHS managers in England. A new pay framework for this group is being developed that does not take account of any local differentiation, and Lansley asked the review body to consider how the framework could be made more responsive to local labour markets. He said that the review body should examine whether the market for these senior posts is national or local and whether or not there are private-sector employers competing for these workers.

The SSRB also received a letter from Francis Maude, Minister for the Cabinet Office, to set out the approach for the senior civil service. Maude said that the issue of market-facing pay would form part of the wider reform of senior civil service reward and would be included in the Government's evidence to the SSRB in the autumn of 2012.

School Teachers' Review Body

Michael Gove, Secretary of State for Education, set out a wider remit for the STRB covering three issues: how the pay framework for teachers should best be made more market-facing in local areas; how the pay scales should be reformed to link pay more effectively to performance, including consideration of progression arrangements; and other reforms that should be made to teachers' pay and conditions to raise the status of the profession and support recruitment and retention of high-quality teachers in all schools.

The STRB had been expecting a remit to review the pay framework with a view to reducing its rigidity since early in 2011, and Gove asked the review body to make recommendations on where progress should be made rapidly and where more detailed work would be needed. The particular areas he asked the review body to advise on were strengthening the link between pay and performance and any barriers to this in the School Teachers' Pay and Conditions Document, including incremental progression pay. He also asked the review body to consider the need for coherence and simplification of the teachers' pay system, and emphasised that any proposals should not lead to an increase in the paybill in the short or long term.

With regard to making pay more market-facing for teachers, the remit letter reiterated the factors the Chancellor had set out in his letter of December 2011.

Gove asked the review body to submit initial findings by 28 September 2012 on how best to implement pay reform and on making pay more market-facing. The review body would then receive a further remit to seek advice on implementing specific options as well as considering the pay award for 2013/14.

Prison Service Pay Review Body

The Government evidence to the PSPRB as part of the 2012/13 pay round included the proposals in the "Fair and Sustainable" document for a new pay and grading structure. The letter from Crispin Blunt, Parliamentary Under-secretary of State for Justice, asked the review body to consider the extent to which these proposals already recognised local market factors, and how or whether they could be built on. Because the new pay arrangements cover staff that fall outside the review body's remit, as well as looking at the implications of market-facing pay for different staff groups within its remit group, the PSPRB was asked to consider the implications of equal pay and read-across to non-remit-group staff. The impact that changes to local pay arrangements might have on pay between neighbouring establishments, and the effect on movement of staff across the country, particularly at senior levels, was a further factor to take into account. The review body was asked what additional information might be needed in future to enable it to make recommendations on local labour markets.

In its evidence on local pay, the National Offender Management Service (NOMS) confirmed that its new pay scheme had addressed problems with the existing local pay scheme and introduced "market-facing rates" that could be built on and adjusted to reflect changes in local markets if necessary. Its pay structure was now aligned more closely with the pay model for the Ministry of Justice (of which NOMS is an executive agency), which has been cited as an example of successful implementation of local pay. The evidence also gave details on the provision under the new reward arrangements for non-consolidated payments to be used to address future recruitment and retention problems, and market supplements, which would be used "only on an exceptional basis". NOMS believes that monitoring and updating will be vital for the scheme to remain effective, and said that in future years it would ask the review body to consider creating more or different local pay zones. More controversially, it said that the review body might be asked to look at whether it is appropriate to hold rates back, or even reduce them, in existing zones.

NOMS concluded that the review body should recommend that the reforms made to the pay system be monitored against local labour-market pay data and changes in recruitment and retention over the coming year. For the 2014/15 pay round, NOMS would review the scheme in consultation with its trade union partners and report on any adjustments to be made in the light of an evaluation of its operation.

The PCS expressed the view that further pay reform would complicate what is already a complex situation with two different pay and grading systems running in parallel and would be a blow to staff morale.

The prison workers' union POA also reiterated its support for the new pay structures, and said that imposition of further changes would undermine the long-term stability it believed the new pay structure had achieved.

NHS Pay Review Body

In December 2011, Lansley confirmed the remit for the NHSPRB to look at market-facing pay for Agenda for Change (AfC) staff. He requested the review body to take account of the extent to which AfC already recognises the impact of local differences in pay through recruitment and retention premia (RRPs) and high-cost area supplements (HCASs) (see box 1), and whether or not these could be used more effectively. Among the other factors to be considered were the need to recognise the implications of market-facing pay for different staff groups at a local level, and the impact of any "cliff edges" in pay between local labour markets and how these might be managed.

However, whereas the Chancellor's letter had instructed the review body to take account of the need to recruit, retain and motivate suitably able and qualified staff across the UK, Lansley acknowledged that his remit letter covered only staff in England. He said: "It will be for each of the devolved administrations to make their own decision whether to provide a separate remit and to communicate this to you. My officials... will do all they can to support you in handling the consequences of any different approaches taken by each country."

The Department of Health (DH) stated its belief that "there is a prima facie case for the introduction of more market-facing pay for AfC staff", which it stated would enable more efficient and effective use of NHS funds. It set out evidence to support its view that market-facing pay for AfC staff "could be achieved fairly, simply, safely and effectively through modest changes to the existing AfC pay framework". It favours a dual approach of additional centrally agreed geographical pay differentiation in the form of new HCAS zones to reflect broad geographical issues, while retaining existing local pay flexibilities such as the use of RRPs to deal with local issues or those involving specific staff groups.

The DH already uses a measure of private-sector geographical pay variation to inform NHS financial allocations, known as the staff market forces factor (sMFF). It proposed that this could be used as a basis for calculating the value of geographical pay differentials, although a range of other factors would need to be considered before specific proposals could be made.

While national collective agreements would be retained, the DH suggested that the national AfC pay rates should be moved towards the minimum level necessary to ensure adequate recruitment in areas where sMFF is low, with the use of HCASs extended to enable employers in higher sMFF areas to recruit and retain high-quality staff. The DH acknowledged that implementation would need to be handled carefully to deliver adequate earnings for all staff and maintain effective industrial relations while ensuring national affordability and local employer stability. It envisaged that the NHSPRB would play a key role in managing this, reviewing HCASs on an annual basis and keeping basic pay awards constrained to fund HCASs and ensure sufficient geographical differentiation in pay.

NHS Employers noted that there is limited desire from employers to move to local pay bargaining, with most looking for increased flexibility through developing the national framework. It stressed that any proposals in relation to market-facing pay would need to be considered in the context of the need to restrain paybill costs. With headline increases averaging 1% in the two years following the pay freeze, NHS Employers said there would be little scope for meaningful pay differentiation during these years.

The staff-side submission emphasised its commitment to national pay determination and national pay structures, stating that these were the best way to achieve the aims of the NHS being a model employer, providing high-quality pay and reward packages, training and development and promoting equality. It said that strong recruitment and retention are best secured through national pay determination, supported by AfC, and feared that moves to a market-facing remit on pay could undermine the whole infrastructure. It called for the review body to "reject outright" any calls for the introduction of such a remit.

Market-facing pay reveals UK split

As Lansley touched on in his remit letter to the NHSPRB, while the NHS AfC agreement covers workers across the UK, responsibility for health matters is devolved to Scotland, Wales and Northern Ireland.

The Deputy First Minister of Scotland and Cabinet Secretary for Health, Wellbeing and Cities Strategy, Nicola Sturgeon, and the Minister for Health and Social Services in the Welsh Government, Lesley Griffiths, wrote a joint letter to the NHSPRB in February 2012 in which they said: "The introduction of market-facing pay raises a number of complex issues and any Government would wish to consider these carefully before committing itself to such a course of action. Neither Scotland nor Wales favour this policy and we do not see the merit in taking such a proposal forward. We will not therefore be providing any such remit to the pay review body."

The letter continued: "We are all aware that if England moves forward with such an approach there may be a range of implications for devolved administrations and it could raise questions about the future of UK-wide pay structures. We would welcome your views on what the pay review body would see as the potential implications of introducing market-facing pay for England while this is not the policy direction of the other countries in the UK."

The NHS staff-side response also raised this issue, saying: "The introduction of market-facing pay for England would also threaten AfC as a UK-wide structure, effectively forcing the hand of the other UK countries."

The Northern Ireland Minister for Finance and Personnel, Sammy Wilson, has expressed opposition to local pay variation, saying: "There is no evidence that national agreed public-sector wages create problems for the private sector in recruiting workers. This is a measure with wide ramifications for individuals and for our economy as a whole and will certainly be vigorously opposed not just by ourselves but by the other two administrations as well as MPs from across the UK since it will impact with equal consequences in the North-East, the North-West and the South-West of England." He believes that seeking to suppress public-sector pay in Northern Ireland relative to London and the South-East will exacerbate differences in economic growth rates across the UK. He has written to the review bodies to register the Northern Ireland Executive's interest in their findings on regional pay and has requested copies of their reports when they are available.

The Scottish Government and Welsh Government also responded to the OME's call for evidence on market-facing pay. John Swinney, Cabinet Secretary for Finance, Employment and Sustainable Growth in the Scottish Government, wrote to the director of the OME and asked that his letter be circulated to the chairs of each of the pay review bodies. He said he wanted to ensure that the OME was fully aware of the Scottish Government's position on market-facing pay. He said: "I do not support this exercise and the Scottish Government does not see the merit in taking this approach forward. Such an approach could, in my view, be damaging to local economies across Scotland and place further pressure on family incomes.

"It could also seriously damage the provision of public services in remote areas by making it more difficult to attract and retain skilled workers in key areas... I am not convinced that regional pay will lead to improvements in service for the public or savings for the taxpayer. Where there are limited numbers of skilled staff available there is a risk that in a country the size of Scotland competition between local areas may drive up wages and the cost of service delivery. I am also concerned that it may be used as a vehicle to cut spending in certain parts of the UK in favour of higher public spending in London and the South-East."

Jane Hutt, Minister for Finance and Leader of the House in the Welsh Government, set out the same concerns about the risks to recruitment and retention of skilled workers in key areas. She said: "I think it is important that you are fully aware of the Welsh Government's position on this issue. The Welsh Government does not support the suggestion that there is an imbalance between private- and public-sector pay which requires correction. We remain concerned about the potential impact local market pay will have on both public-service workers and the wider economy at a time of financial pressure.

"We also take the view that fair and reasonable levels of public-sector pay are an important contributor to economic performance in less advantaged areas."

The Welsh Government submitted a paper by its chief economist responding to what it described as the Treasury's "incomplete, and in places, flawed" evidence to the review bodies. This analysis found that the figure of an 18% pay premium for the public sector in Wales cited by the Treasury "is not supported by analysis using more appropriate sources of data", and concluded that there is no clear evidence of a persistent or uniform public/private pay differential in Wales.

Both Governments asked the pay review bodies to work with the relevant departments in their administrations to ensure that the implications of the review bodies' work for Scotland and Wales were fully understood.