Box D: Public-sector wages: A view from economic theory

In a well-functioning private-sector labour market, the wage is an allocative mechanism that responds to market forces of supply and demand. In the public sector, wages are an allocative mechanism, but also a policy instrument. The government has the power to unilaterally change the conditions of many of its labour contracts. Plus, wage growth is one of the key political decisions when preparing the yearly budget. Ideally, policymakers should set employment at a level high enough to produce the public goods that the citizens wish for and pay a wage that clears the market. In general, that is the wage paid by the private sector, except when the public sector offers additional compensating benefits, like job-security, better pensions, or better work-life balance. In those cases, the public(-sector) wage should reflect those differences and be lower than that of the private sector. Out of a perfect world, wage determination is much more complex, because public wages are used as an instrument to achieve many, sometimes conflicting, objectives, creating differentials with the private sector and imbalances in the labour market.