Next Monday employers, trade unions and the Government sit down for the first time to discuss the pay round for the second 18 months of the national agreement, writes Cliff Taylor, Economics Editor

All the signs are that the negotiations will be tense and difficult against the backdrop of vastly different starting positions from the employers and unions on pay, and serious industrial unrest in the State sector.

Add in some tensions in the union movement and questioning from some employers about the value of the whole partnership process and the scene is set for quite a battle.

Crucial to the process is what precisely will be on the agenda. Are the talks purely about the pay terms for the second 18 months of Sustaining Progress? (The first phase runs out in the middle of this year for the private sector and the end of the year for public servants.)

Or will the trade unions manage to cajole the Government into also talking about wider policy issues such as tax and social and affordable housing? And how will the stoppage at An Post and the difficulties at Aer Rianta and CIÉ affect the discussions?

Two scenarios are possible. The first would see talks purely about pay, with the employers - represented by IBEC and the CIF - likely to argue for terms in line with or even a bit below the current low inflation rate of less than 2 per cent and the trade unions seeking a substantial premium on inflation to reflect the growth in the economy.

Given the pressures on both sides from their own constituencies, agreement on this narrow agenda could prove very tricky.

The second would see a broadening of the talks agenda to include issues such as tax policy and the future of the State sector.

This route has the potential to get messy. If either side tries to use the situation in the State companies as leverage, for example, the potential complications are obvious.

The senior civil servants and their Ministers who are involved in the talks thus have an important call to make in setting down the agenda.

Given how live the issues are in the State companies, they are bound to have an influence in some way, even if they are excluded from the formal agenda of the talks.

Monday's talks will kick off the process and serious engagement is not likely until after Easter. The employers will set out their stall, following the script set down by IBEC director general Turlough O'Sullivan in its presentation earlier this week.

Competitiveness is under threat, they will argue, the recovery cannot be guaranteed and pay in the first 18 months of the deal has risen ahead of inflation. While it may not be stated explicitly, many employers are also exercised by the size of the benchmarking awards paid to public servants and the implications for the Exchequer finances.

The talks should be purely about pay, the employers are likely to argue, with the other parts of Sustaining Progress already in place and due to run for the full term of the agreement to the end of 2005.

Not surprisingly, the trade unions, led by ICTU's general secretary David Begg, will take a different approach. They will point out that, while inflation may be easing, the actual level of prices is one of the highest in the EU. And this is before considering the cost of buying a house.

The unions will also argue, forcefully, that pay increases over the past couple of years have been eaten up by a range of increases in utility prices - particularly ESB costs - higher user charges in areas such as refuse and by the creep of their members into the higher tax bracket.

The Minister for Finance, Mr McCreevy, has failed fully to index tax credits and the standard rate band in the last two budgets, increasing the proportion of income taken in tax for many middle- and higher-income earners, when wage inflation is taken into account.

The partnership process was originally born in the teeth of the fiscal crisis of the late 1980s. The aptly named Programme for National Recovery helped to steer the economy away from the rocks and - together with the political consensus enabled by Alan Dukes's Tallaght strategy - paved the way for painful cutbacks in Government spending.

However, subsequent programmes rewarded employees through a combination of moderate wage increases and tax concessions.

This gave a significant boost to take-home pay while maintaining competitiveness through restraining wage cost growth.

This point is illustrated in the report done by the National Economic and Social Council in the run-up to the negotiations on Sustaining Progress. It showed that between 1987 and 2001, gross average industrial earnings rose in real terms by 25 per cent.

However the increase in real (that is inflation-adjusted) take-home pay was substantially greater, with a 60 per cent increase for a single person on average manufacturing earnings over the period and a 54 per cent rise for a married person.

However, the end of the "Tiger" years hit Exchequer finances. Income tax rates have remained static, but the lack of indexation of the system has taken a share of wage increases. Pressure on the national finances has also contributed to a range of other cost increases from indirect taxes to refuse collection to hospital charges.

Calculations by the Central Statistics Office showed that last December's indirect tax increases accounted for more than half of the annual inflation rate of 1.9 per cent.

Even after the more moderate increase in last December's budget, the February figures still showed that just over one-third of the annual 1.7 per cent increase in the rate of inflation in the year to February was due to indirect taxes.

And this is before account is taken of higher services charges or increases in areas such as electricity, which the unions also argue are a function of Government policy.

A central issue for the trade unions is the potentially significant impact of further indirect tax increases or rises in user charges in a low-inflation environment. If pay increases are to moderate in tandem with inflation, they will look for clear guarantees from Government on this issues.

And they are also likely to push for commitments that the tax credits and the standard rate band will be indexed, to ensure that wage increases are not eaten into by a higher tax take.

The employers, while their position is that pay should be the sole focus, would not be likely to have any difficulty with commitments on taxation, particularly if they contributed to lower wage increases.

But as Mr McCreevy has been strongly averse to any firm commitments on budgetary policy, saying this is a matter for the Government and the democratic process.

His officials will also resist any firm commitments, arguing that they could jeopardise the Exchequer finances. Whether there will be any "give" from Finance will be a key issue in the talks.

Meanwhile, the unions will also hope for some further commitments in social and affordable housing, to help to "sell" any package to their members.

The other big uncertainty is the impact of the current industrial unrest in State companies. This is an exceptionally delicate area for both sides.

A clause in Sustaining Progress "precludes strikes or other forms of industrial action by trade unions, employees or employers in respect of any matters covered by this Agreement, where the employer or trade union concerned is acting in accordance with the provisions of this Agreement". How the situation in An Post fits in with this is very much open to question.

The unions also have grave concerns about Government policy in Aer Rianta and CIÉ - and have members in both organisations who are pressing for a more militant approach.

The employers, understandably, will argue strongly against any "linkage" between the State sector upheaval and the talks.

The last thing they will want will be any suggestion that pay increase levels can be traded against industrial peace in theState sector. However, unless progress is made on resolving the conflict in State companies, this issue is threatening to overshadow the talks and could make agreement even more difficult.