Managing Government Compensation and Employment – Institutions, Policies, and Reform Challenges
Government compensation and employment policies are important for the efficient delivery of public services which are crucial for the functioning of economies and the general prosperity of societies. On average, spending on the wage bill absorbs around one-fifth of total spending. Cross-country variation in wage spending reflects, in part, national choices about the government’s role in priority sectors, as well as variations in the level of economic development and resource constraints.
Pressures on wage spending will increase over the coming decades in many countries. Advanced economies are facing fiscal challenges associated with aging populations while also needing to reduce high public debt levels. Emerging markets and low-income countries have pressures to expand public service coverage in the context of revenue and financing constraints and the need for higher public investment.
Effective management of wage bill spending is needed to ensure that the desired public services are delivered in a cost-effective and fiscally sustainable manner. This requires adequate fiscal planning to ensure appropriate financing of the wage bill, competitive compensation to attract and retain skilled staff and incentivize performance, and the flexibility to adjust the level and composition of employment to respond efficiently to demographic and technological developments. Experience has shown that countries across all income levels have faced challenges in these areas.
Strengthening institutions is crucial for effective and sustainable wage bill management. For example, improving medium-term wage forecasting, and strengthening links between wage determination processes and fiscal frameworks, can enhance fiscal planning. Competitive compensation can be promoted through public and private sector wage comparisons. Position-based employment systems can give greater flexibility to adjust employment levels to ensure efficient service delivery.
Investing in better monitoring and information systems can greatly contribute to more effective wage bill management. The current lack of data on the level and composition of wage bill spending and employment levels reflect the precarious state of systems for monitoring and reporting wage bill spending.
The efficient delivery of public services is crucial for the functioning of economies and the broader prosperity of societies. Governments typically play a key role in the provision of critical services such as education, health, sanitation and security. Broad access to these services promotes inclusive growth and the general well-being of populations. Government compensation and employment policies foster better compensation and employment standards, including equality of pay and employment opportunities for women, ethnic minorities, those with disabilities, the low skilled, and disadvantaged groups.
Reflecting the critical role of public services, government wage bill constitutes a large share of government spending in all countries. On average, spending on the government wage bill varies between 10 percent of GDP in advanced economies to 7½ percent of GDP in low-income developing countries (LIDCs), with emerging market economies lying in between. However, the wage bill as a share of total government spending is higher at 27 percent in emerging markets and LIDCs compared to 24 percent in advanced economies.
Government compensation and employment policies have important fiscal and macroeconomic implications:
- Wage bill spending can impact the fiscal balance and the composition of government expenditures. If not effectively integrated into budget planning, high or increasing wage bills can undermine fiscal planning. In addition, raising government wages or boosting hiring during cyclical upturns can exacerbate output fluctuations by further stimulating demand, hindering the stabilizing role of fiscal policy and ratcheting up public debt during the downturn as compensation increases are often hard to reverse. High compensation spending can also crowd out priority spending on public infrastructure and social protection, crucial for economic growth and poverty reduction.
- In many countries, the government is the principal employer and thus can have an impact on private sector wages and employment. (Government employment ranges from 11.6 percent of the working age population in advanced to 8.3 percent in emerging markets and 3.7 percent in LIDCs.) Government compensation policies can influence private sector wages by increasing reservation wages and crowding out private sector employment. Using government employment to compensate for insufficient labour market demand can lead to skill shortages in the private sector without increasing aggregate employment over the long term.
- The wide cross-country variation in government employment levels reflects in part national choices about the role of government. Among advanced economies, whereas the Nordic countries (including Denmark, Norway and Sweden) employ a relatively large proportion of their population in the provision of public services (between 20-25 percent of the working age population), countries such as Australia, New Zealand and Japan employ much smaller shares at less than 10 percent. The picture is similarly mixed among emerging markets and LIDCs. For instance, in LIDCs such as Kyrgyz Republic and Moldova government employment exceeds 4½ percent of the population, while other LIDCs have lower levels of government employment reflecting, for example, the lack of revenue capacity.
Emerging fiscal pressures in many countries require a renewed focus on the efficiency of government spending, including wage bill spending. Advanced economies face the dual challenge of financing high debt levels as well as rising pension and health spending due to rapidly ageing populations. (While migration can partially help to ease these challenges, it has implications for the level and composition of public services in both the host and origin countries.) At the same time, countries need to ensure that measures taken to contain the wage bill as part of fiscal consolidation do not unravel. Emerging market economies and LIDCs need to finance expansion in public infrastructure as well as in access to education and health care to support inclusive economic growth and poverty alleviation. Limited resource mobilization capacity in the short term and competing expenditure needs mean that these countries will require a strong focus on government spending efficiency, including the wage bill. Measures adopted by countries may also require a reallocation of employment across sectors (e.g., from education to health in advanced economies, or an increasing share of education and health in emerging markets and LIDCs) as well as enhancing the efficient delivery of public services by ensuring “value for money”.
Over the long run, rising incomes and to some extent technological change could raise government compensation as a share of GDP, especially in emerging markets and LIDCs. According to “Wagner’s Law”, government spending—including the wage bill— tends to increase as a share of GDP as countries develop, reflecting increasing demand for public services such as education, health, security and regulatory services. In addition, if the government sector does not benefit from the productivity increases in the private sector induced by technological change, then this can further increase government compensation as a share of GDP as private sector wages are transmitted to the public sector to ensure government wages remain competitive —the “Baumol cost disease”. Lack of flexibility in changing the level and composition of the government labour force and failure to exploit the opportunities presented by new technologies and work practices can further reinforce this trend.
Against the above background, effective management of the government wage bill requires appropriate institutions and policies to ensure that governments can efficiently provide the desired level of public services in a fiscally sustainable manner. This, in turn, requires:
- Adequate fiscal planning: Integration of decisions on government wage and employment levels into a medium-term budget framework can ensure that increases in the wage bill are appropriately financed. Otherwise increases in the wage bill can have unintended adverse implications for the fiscal balance requiring disruptive fiscal adjustment over the medium term to ensure fiscal sustainability.
- Competitive government compensation: The level, composition and structure of government compensation need to be competitive with the private sector to attract, develop and retain the required talent and to incentivize performance. If government compensation packages are uncompetitive, then governments will be unable to attract adequately skilled staff to provide quality public services. (For example, low pay can result in poor service delivery due to absenteeism or corruption in the form of informal payments by service recipients.) On the other hand, if government compensation is too generous then this can create upward pressure on private sector wages, and require higher taxation or lower government expenditures on items such as infrastructure or social protection which are crucial for economic growth and poverty reduction.
- Appropriate government employment. Both the level and skill composition of government employment needs to be consistent with the effective delivery of public services. (This includes not only services such as education, health, water and sanitation, and law and order, but also the collection of government revenues to finance these expenditures.)
- Efficient delivery of public services also requires that the government has the flexibility to adjust, upwards or downwards, the size and composition of employment to achieve fiscal and policy objectives, including exploiting the growing opportunities created by technological innovation.
Therefore, not only does total wage bill spending need to be fiscally sustainable, but the underlying wage and employment mechanisms have to be efficient. Drawing on the work of other international institutions, including the World Bank, the International Monetary Fund regularly advises its member countries on managing the wage bill, in the context of surveillance, lending and technical assistance.
Pressures on wage bill spending will continue to increase over the coming decades across all income groups. In advanced economies, ageing populations will raise demands for health care services at a time when fiscal consolidation is required to address elevated debt levels. In many emerging market economies and LIDCs, the goal of expanding service delivery in key sectors such as education and health will result in increases in the wage bill. Effective institutions and policies are required to ensure that increased spending on the wage bill is reflected in the cost effective delivery of quality public services in a fiscally sustainable manner.
Effectively managing the wage bill has been a challenge, with implications for fiscal planning, competitive compensation, and efficiency of government spending.
- Increases in the wage bill have typically been associated with a deterioration of short-term fiscal balances, which can disrupt budget planning and service delivery plans. In particular, many governments have difficulty in containing wage bill spending during economic upswings and prior to elections.
- Increases in government wage levels are transmitted to private sector wages with potentially adverse implications for output and employment. A large public-private wage premium in LIDCs can act as a barrier to expanding service delivery in a fiscally sustainable manner and increase cost pressures in the private sector.
- The inability to flexibly adjust employment levels and composition in response to demographic and technological change has resulted in inefficiencies in service delivery. For instance, in advanced economies, failure to decrease the number of teachers in line with the decline in the school-aged population has resulted in excessive employment levels without any commensurate improvement in education outcomes. Similarly, over-reliance on hospital-based care instead of more cost-effective primary care has meant that increases in demand for health care have accelerated public health spending.
In their efforts to contain wage pressures, governments have often resorted to blunt measures to reduce high wage bills, which only provide temporary relief. Governments have typically relied on quick fixes such as across-the-board freezes in wage and employment levels. While these measures can be effective in reducing wage bill spending in the short term, they tend to decrease morale, distort wage and employment structures, and adversely affect service delivery. As a result, they tend to unravel over the medium term resulting in recurring wage bill pressures. Undertaking functional reviews to inform structural reforms, as well as institutional reforms that focus on weaknesses in the management of wage and employment processes, can help prevent the recurrence of wage bill pressures.
Strong institutions, tailored to countries’ income levels and administrative capacities, are needed to effectively manage the wage bill over the medium term. Among countries with low capacity, centralization of wage bill budgeting, wage determination, and workforce management in the Ministry of Finance or another central agency is important to safeguard fiscal planning. As countries develop higher capacity and modernized governance and administrative systems, progressive decentralization of wage bill management to line ministries and agencies can help governments better adapt their services to changing demands of citizens and to new technologies. However, decentralization needs to be guided by centrally set standards which promote decisions on hiring, promotion, and pay levels based on performance and productivity.
Various institutional arrangements for setting government wages and employment are associated with effective fiscal planning, competitive compensation and flexibility.
- Medium-term forecasting of the wage bill supports better fiscal outcomes. Incorporating wage forecasts within a medium-term budget framework can help to strengthen fiscal planning and the achievement of fiscal objectives.
- Wage negotiations on an annual or multi-annual basis, as opposed to ad hoc or ongoing negotiations during the year is associated with better fiscal planning.
- Regular comparisons between public and private sector wages are associated with lower public private wage differentials and enhanced ability to attract staff with needed skills.
- Position-based employment systems facilitate greater flexibility in workforce deployment when compared with career-based systems.
The ceilings on wage bill and employment do not appear to be effective for advanced economies in terms of fiscal planning. Ceilings on the wage bill or employment numbers appear to be put in place as a crisis management mechanism to counterbalance more fundamental institutional weaknesses. In addition, introducing ceilings without first reviewing government expenditure and activities locks in existing inefficiencies making structural reform more difficult. Advanced economies tend to use fiscal frameworks to contain their total spending, including the wage bill.
Structural reforms that target sectors with excessive employment and wage levels are required for more sustained wage bill adjustment while protecting service delivery. Examples of structural reforms include:
- The adoption of a unified wage scale can help ensure wage levels are competitive, equitable and transparent. However, the transition to such a system requires administrative capacity and needs to be carefully managed to avoid unintended wage increases and reduced wage flexibility.
- Strengthening human resource management, including through implementing a census of government employees, can help to identify areas of inefficiency, overstaffing or the existence of “ghost workers”. While separation incentives, such as enhanced severance packages and early retirement schemes, can help achieve larger reductions in employment they are most effective when targeted at redundant workers to prevent a deterioration of services and pressures for rehiring over the medium term.
- Public sector restructuring through downsizing, mergers of functions and organizations, outsourcing and privatization can help to lock in more efficient employment levels but need to be based on a prior functional review and therefore take time to implement.
It remains a concern that while figures for total compensation of employees are widely available on a timely basis for most countries, employment headcounts are not, as in the case of Guyana. At a minimum, governments could aim to track periodically both the number of government employees and total compensation paid to these employees. These simple data can prove helpful to policymakers in determining the source of temporary wage bill pressures—do wage bill developments reflect changes in employment or in compensation? These data can also allow for comparisons across countries to help benchmark wage bill outcomes. Furthermore, if shared publicly, these would enhance transparency by allowing constituents to better understand the magnitude of direct provision of government services, including monetary (compensation) and human (employment) resources. An example of good practices is Portugal, which publishes online quarterly reports on public employment and pay, including by entity, economic activity, and post.
Investment in developing information technology systems to monitor the wage bill and public work processes could greatly contribute to improving the management of wage bill spending and enhancing service delivery. The current poor state of information on the level and composition of wage bill spending, and in particular employment, reflects the precarious state of systems for monitoring and reporting wage bill spending within countries. This is especially the case beyond the general government. Beyond aggregate compensation and employment figures, governments could aim to monitor the composition of pay (base wages, allowances, bonuses, in-kind compensation, overtime, and social security contributions), the areas of employment (for example, by functional classification including education, health, and security), the type of employment (permanent or contractual; full time or part time), and the type of worker (clerical, service, professional or managerial). Disaggregation across these dimensions can be supported by modern information technology systems. Better information can greatly help to: enhance wage bill management through improved budget preparation and wage bill forecasting; monitor wage and employment over the medium term consistent with fiscal objectives; engage in better workforce planning; and design and evaluate wage and employment measures aimed at improving service delivery. A number of developing countries have introduced biometrics to help improve public sector performance, including eliminating double-dipping and ghost workers as well as monitoring attendance.