View from City Road: Profit-related pay is no panacea for economic ills

Profit-related pay (PRP) was hailed in the mid-1980s as a miracle cure for Britain's economic ills. It would help to achieve lower unemployment for a given rate of inflation by making pay more flexible. The early over-excitement soon subsided, but the schemes have since enjoyed a steady gain in popularity.

The Inland Revenue announced yesterday that 1,167,400 people were signed up to 4,615 officially recognised schemes at the end of March. The number of participants took off after Norman Lamont doubled the tax relief on PRP two years ago, allowing employees to receive up to pounds 4,000, or 20 per cent of their salaries, tax-free.

As the schemes have been made more popular the cost of tax relief has risen to nearly pounds 400m a year. But the hard evidence of economic benefits to justify these costs is still surprisingly thin on the ground.

PRP is supposed to soothe industrial conflict by giving both workers and shareholders an interest in profitability, thus boosting productivity and effort. It is also supposed to reduce job turnover, because workers' remuneration falls automatically as profits fall, reducing the need to cut costs through redundancy.

But the case is shaky. Firms with poor industrial relations are reluctant to try PRP as it provides something else to squabble over. Enlightened employers with happy, productive workers are more likely to have PRP, but that may be a result rather than a cause of their good performance. Some companies adopting official PRP schemes may simply be adapting pre-existing schemes to obtain tax relief.

The benefit to job mobility and employment is also doubtful, as workers may demand that a fall in the profit payout is compensated for by a rise in basic pay. In extreme cases, falls in profit payouts can destabilise entire schemes, as happened in 1990 with the scheme covering 26,000 employees in Du Pont's US fibres business.

The best that can be said with confidence is that PRP, on average, hands public money to efficient companies. This may not do much damage, but it is certainly no panacea.