Can pay regulation kill?

Here is a discussion, by Carol Propper and John Van Reenenof, of a new paper that argues pay regulations can kill. Economists have long warned of the unintended consequences of market regulation, including regulation of the labour market. What seems "fair" on the face of it – like paying people the same wage for doing the same job regardless of where they work – may turn out in practice to be foul. While economists often worry about the minimum wage pricing people out of jobs, a regulation that can impose a maximum wage and price people out of jobs has received little attention. Propper and Van Reenenof point out that an example of such a pay regulation is centralised wage-setting, where pay is mandated to be (almost) the same across different labour markets, effectively imposing a maximum wage on people living in areas where labour markets outside the regulated sector are strong.

This kind of centralised pay-setting happens in many public sector labour markets like health, teaching and the police. Nowhere is centralised pay-setting more important than in the UK National Health Service (NHS). More than a quarter million nurses in England have their pay set by a single pay review body. The process allows some local flexibility, but in practice the gap between the wages paid to a nurse in a low outside wage area – such as Newcastle in the North East – and a high wage area –such as London –is small compared to the pay gap between women who are not nurses. In recent research, we examine in detail how centralised pay-setting for nurses in the NHS affects hospital performance by tracking changes in the outside wage and changes in performance in over 100 English hospitals over a six-year period. (Hall et al. 2008)

The outcomes of the centralised pay system can be fatal. The pay regulation means that hospitals which are in high wage areas treat fewer patients and these patients have poorer health outcomes. And these effects are far from minor. Results from the Hall et al. (2008) study point to that fact that a 10% increase in the gap between the wages paid to NHS nurses and those paid to women working in the private sector locally raises the fatality rate among people admitted with a heart attack by 5%. To put this into perspective the size of this effect is not dissimilar to the reductions in heart attack fatalities brought about by the greater use of aspirin and other clot-busting drugs in recent years.

What Hall et al. (2008) did was look at the quality and productivity of nursing across the UK, this being measured by the percentage of those admitted to hospital after a heart attack who died in the subsequent 30 days. What was found was that the richer the area surrounding the hospital the worse the survival rate. This is in contrary to what we would expect given the often discussed connection between poverty and bad health. We would expect the death rates to be higher in poor areas. The reason for this "rich area effect" is the centralised pay-setting which results in wages being the same right across the country, with little responsiveness to local labour market conditions. But it isn't that nurses wages are too high in low wage areas, but that they are too low in high wage areas. In high wage areas this leads to both a shortage of people willing to do the job itself and hospitals relying upon agency staff who are not constrained by the national pay scale. The problem with this is that the agency staff are, by the very nature of their shift by shift employment, unlikely to know the systems and hospitals as well as permanent staff. Local and tacit knowledge gained via experience in that particular situation is important and unknown to the agency staff. This lowers the quality of care and people die.

The answer, at least as far as the Adam Smith Institute see it,

is to abolish such national pay rates and allow local employers to pay what they need to attract the staff they desire.

This makes sense, and may save lives.