Pay and Benefits in the Public Sector

1. Pay and Benefits in the Public Sector Martin Rama Development Research Group Public Expenditure Analysis & Management Staff Training Course Washington, DC, May 22-24, 2001

2. The Problem • The wage bill is usually the largest item in public sector spending • Salaries and benefits result from historic legacies, fiscal adjustments, political pressures, etc. • Pay tends to be compressed compared to the private sector (low top-to-bottom ratios) • Low pay could lead to the departure of qualified staff and encourage corruption

3. The Solution • Pay and benefits should be similar in the public and the private sectors • An immediate alignment may not be feasible, but the direction should be clear • The alignment may lead to gains for some public sector workers, and losses for others

4. Methodological Issues • The “private sector” is very heterogeneous in developing countries (formal versus informal activities) • Benefits account for a different share of total compensation in the public sector and in the private sector(s) • Some important benefits (job security, low effort…) are difficult to quantify

5. In Practice, Two Strategies • The jobs approach: estimate the total compensation associated with “similar” jobs in the private sector (e.g. secretary, driver) • The workers approach: estimate the total compensation a public sector worker would get if he/she had to move to the private sector

6. The Jobs Approach • Widely used in industrial countries, and even by the World Bank (Hay points) • Relies on the identification of appropriate private sector “comparators” • Problem: the chosen “comparators” are often the best companies in the formal sector • Experience from downsizing shows that many public sector workers end up in the informal sector. • Example: the 2000 arbitration award in Guyana, doubling government pay.

7. An illustration: State-owned Enterprises in Vietnam

8. The Workers Approach • Relies on the estimation of the pay and benefits a specific worker would get if he/she moved out of the public sector • This is the same as estimating the amount of compensation he/she would need in the event of job separation • Implication: a public sector worker cannot be both underpaid and reluctant to leave in exchange for generous compensation

9. Implementation of this Approach • Rely on household survey data (e.g. LSMS) to estimate private sector earnings as a function of worker characteristics (age, education, etc.) • Predict alternative earnings of public sector workers by plugging their individual characteristics into the estimated earnings function • Use the distribution of estimated earnings gaps to infer the value of intangible public sector benefits (more on this below)

10. Main Potential Weakness • Public sector workers may be different from private sector workers in unobservable ways (e.g. they could be better connected, or less entrepreneurial) • Failure to control for unobservable characteristics will bias the estimates (e.g. we will compare with the private sector earnings of someone who is not well connected, or is more entrepreneurial) • How serious is this potential bias?

11. An Illustration: State-owned Enterprises in Vietnam • If the bias from unobservable characteristics matters, then it has to matter in Vietnam’s SOEs • Under central planning, SOE jobs were deliberately allocated based on political loyalty and to compensate for sacrifices during independence wars • In the early 1990s, a voluntary downsizing program led to the departure of the most entrepreneurial third of the SOE workforce.

12. Six Ways to Estimate the Gap • OLS: Estimates earnings functions based on observable characteristics only • HECKMAN: Standard approach to correct for self-selection on unobservable characteristics • SWITCHING: More elaborate version of the above • FE-TIME: Focuses on workers who shift from public to private sector or vice-versa • FE-HHOLD: Focuses on individuals who belong to the same household but work in public versus private sector. • MATCHING: Compares with most similar private sector worker(s), rather than with a regression line.

13. Some Results

14. A Crude Comparison • The jobs approach suggests that SOE workers earn 4 to 8 times less than private sector workers • The workers approach shows that they actually earn about 30 percent more • The mean and median gap are stable, regardless of the econometric technique used • Even individual gaps are quite stable, as revealed by the significant correlation coefficients

15. Assessing Benefits • Both the jobs approach and the workers approach assume that benefits are the same in the public and the private sectors • The comparators chosen in the jobs approach may offer similar benefits, but they require higher effort and provide less job security • Benefits such as health coverage and old-age pension are usually unavailable in the informal sector

16. Methods to Assess Benefits • Direct method: Calculate the value of the most significant benefits available in the public sector but not in the informal sector (e.g. old-age pension) • Indirect method: If a worker who could earn X% more in the private sector does not leave voluntarily, he/she must value the intangible benefits at X% of his/her salary at least.

17. An Illustration: Civil Servants in Guinea-Bissau

18. Main Findings in Guinea-Bissau • All civil servants in N-Z categories would lose if they moved to the informal sector, but a quarter of them would earn more in the private formal sector • Based on the estimated gains, and the probability of finding a job in the private formal sector, the value of intangible benefits is around 20 percent of the measurable earnings • The direct method, based on the present value of old-age pension, yields similar results

19. Conclusions • Having clear benchmarks is important to reform public sector pay over time, minimizing risks of either over-spending or losing qualified personnel • The jobs approach yields an excessively high benchmark, because it focuses on the best companies, and not on the true alternatives of public sector workers • The workers approach can be implemented in any country with decent household survey data, of the kind we use in our poverty work

20. Conclusions (Contd.) • The main weakness of the workers approach is the potential bias created by unobservable worker characteristics • However, this bias does not appear to be substantial, and even simple econometric techniques (such as OLS) could yield decent results • The workers approach can also be used to estimate the value of intangible benefits offered by the public sector, which are part of total compensation

21. References Cited in the presentation: Bales, Sarah and Martin Rama (2001): “Are Public Sector Workers Underpaid? Appropriate Comparators in a Developing Country”, work in progress, Washington, DC: The World Bank. Chong, Alberto and Martín Rama (2001): “Do Compensation Packages Need to Be that Generous? Simulations for Government Employees in Guinea-Bissau”, in Shantayanan Devarajan, F. Halsey Rogers and Lyn Squire (eds.): World Bank Economists’ Forum, 1, p. 169-194, Washington, DC: The World Bank. Other references: Adamchik, Vera A. and Arjun S. Bedi (2000): “Wage Differentials between the Public and the Private Sector: Evidence from an Economy in Transition”, Labour Economics, 7(2), p. 203-224, March. Filmer, Deon and David Lindauer (2001): “Does Indonesia Have a ‘Low Pay’ Civil Service?” unpublished manuscript, Washington, DC: The World Bank. Hou, Jack W. (1993): “Public-Private Wage Comparison: A Case Study of Taiwan”, Journal of Asian Economics, 4(2), p. 347-362, Fall. Lindauer, David and Richard H. Sabot (1983): “The Public-Private Wage Differential in a Poor Urban Economy”, Journal of Development Economics, 12(1-2), p. 137-152, February-April. Mengistae, Taye (1998): “Wage Rates and Job Queues: Does the Public Sector Overpay in Ethiopia?”, Working Paper Series, WPS/98-20, Oxford, UK: Centre for the Study of African Economies”, December. Psacharopoulos, George, Jorge Valenzuela and Mary Arends (1996): “Teacher Salaries in Latin America: a Review”, Economics of Education Review, 15(4), p. 401-406. Stelcner, Morton, Jacques van de Gaag and Wim Vijverberg (1989): “A Switching Regression Model of Public-Private Sector Wage Differentials in Peru: 1985-86”, Journal of Human Resources, 24(3), p. 545-559, Summer. Terrell, Katherine (1993): “Public-Private Wage Differentials in Haiti: Do Public Servants Earn a Rent?”, Journal of Development Economics, 42(2), p. 293-314, December.