a. Forms of salary supplements

There is a wide variety of pay supplements. The Central Payroll Service in Senegal, for example, produces a monthly computer printout entitled “General Summary of Items of Pay,” which is made up of 250 items of which 175 are pay supplements (see Appendix Table 1). Furthermore, the nonsalary allowance and fringe benefit systems adopted by governments differ greatly among countries, both in terms of types and amounts, as illustrated for selected African countries in Appendix Table 2. The following list enumerates those groups of pay supplements that can be frequently found in government pay systems.

(1) Probably the most common nonsalary allowances in government pay systems are those for spouse and children. In Indonesia, for example, the spouse allowance is 5 percent of the basic salary.

(2) Free or subsidized provision of housing is in many African countries an important benefit in kind in the government compensation system, a tradition inherited from the colonial period. In Malawi, for example, all established civil servants are eligible to be provided with accommodation. Alternatively, rather than providing the accommodation, in some countries, the government provides cash housing allowances or housing loans at preferential rates. In Zambia, several housing benefits exist at the same time: houses are provided to those who have been in the civil service for a long time. Employees who do not get housed and have to rent a house receive an “own-arrangement” allowance. Further, those who own houses are also given a housing allowance based on the value of their house. ^16/

(3) Pensions may be singled out as the most important kind of deferred compensation. Government employees accumulate claims as compensation for present efforts, while the government concurrently accrues liabilities that it has to discharge sometime in the future.

(4) Other social benefits may include government contributions to invalidity, life, and health insurance schemes. These are much more important in developed than in developing countries.

(5) Travel per diems, like other reimbursements of expenses incurred in the course of duty, can only be considered a remuneration of labor services insofar as they exceed the expenses actually incurred.

(6) In some countries, public agencies provide regular transport to and from work enabling the government to recruit in a wider area and to increase regular attendance. Also, higher ranking government employees are frequently provided with a government car, which they may use for private purposes.

(7) In a number of countries, allowances are granted to civil servants because of the position they hold. In Senegal, all teachers get a teacher allowance, amounting to 20 percent of their base salary. Similarly, in the Indonesian civil service, a certain number of employees receive a rank supplement of 20 percent of the base pay. In Sri Lanka, an exodus allowance is paid to capable managers to induce them not to leave the country. In the Federal Republic of Germany, civil servants receive a special allowance if they are with the central government.

(8) Leave-with-pay policies (such as annual, sick, sabbatical leave) are fairly common but vary considerably among countries. Parallel to efforts to reduce working hours, such fringe benefits have shown an increasing trend in developed countries in recent years. In the Federal Republic of Germany, for instance, time off with pay in connection with the birth of children was introduced a few years ago and is now eight months (both in the private and public sector).

b. Classification

The above list indicates that in the area of pay supplements, policymakers are faced with rather complex systems comprising a wide variety of different forms of compensation, many of which differ fundamentally from the base salary in terms of economic and other effects. Before discussing the main economic issues concerning nonwage allowances and fringe benefits in government pay systems, some of their common or differentiating features should be pointed out (see Chart 1).

Classification of Pay Supplements

Citation: IMF Working Papers 1988, 073; 10.5089/9781451958461.001.A001

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Classification of Pay Supplements

Citation: IMF Working Papers 1988, 073; 10.5089/9781451958461.001.A001

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Classification of Pay Supplements

Citation: IMF Working Papers 1988, 073; 10.5089/9781451958461.001.A001

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(1) A pay supplement may be contingent upon a criterion or may be granted across the board. Frequently, pay supplements are contingent upon certain criteria such as family status or grade. Noncontingent pay supplements include pensions and government contributions to health, life, and other insurance schemes.

(2) Nonsalary allowances and fringe benefits can be provided in cash or in kind. In many cases, pay supplements are provided in cash. Housing may be singled out as the most important fringe benefit of the in-kind category in a number of developing countries. In-kind supplements are typically not transferable into other goods, are determined in real terms (and thus insulated against inflation), and frequently do not show up in the government budget as an expenditure item.

(3) The majority of pay supplements is provided concurrently with the labor service rendered; deferred payments, such as pensions, are less frequent. Deferred payments do not lead to cash outlays in the period the labor service is rendered but affect government finances in the future.

(4) Pay supplements can be fixed as a percentage of the basic salary, such as pensions or typically spouse and children allowances, or can be unrelated to the basic salary, such as free lunches or transportation to and from work. Pay supplements as a fraction of the base salary augment the compensation of individuals at all grades by the same percentage amount. Conversely, pay supplements determined as an absolute amount augment the base pay by declining percentage amounts as civil servants move up the pay scales system.

c. Quantitative importance

Reflecting the tremendous array of pay supplements offered to government employees in exchange for their labor services, as well as problems of their measurement, classification, and valuation, information available on the quantitative importance of pay supplements in government compensation systems is minimal. Impressionistic evidence suggests that nonwage allowances and fringe benefits play an important role in pay packages offered by governments; they sometimes account for a larger share in the total compensation of a civil servant than his base pay. In Indonesia, for instance, the basic pay (including spouse, children, rice allowance, and rank supplement) is, as estimated by Gray (1979), well below 50 percent for most officials. In Nigeria, pay supplements can constitute from 35 to 100 percent of the base salary (Lindauer, Meesook, and Suebsaeng (1988)). In Senegal, pay supplements account for almost 40 percent of the average civil service compensation package (see Appendix Table 1), without including, inter alia, pension claims and benefits in kind. ^17/

Detailed studies are available for housing benefits for government employees in Malawi and Zambia. These studies suggest that the payment in kind which the government is making to those civil servants who occupy government houses at highly subsidized rents is a major part of the rewards of civil service employment. Appendix Table 3 shows that in Malawi the value of these benefits can exceed 150 percent of the base salary.

d. Issues

A number of issues have to be taken into account in the design of a compensation package with respect to pay supplements. ^18/ These include the impact of pay supplements on the productivity of employees, their distributional effects, the cash orientation of the system of pay supplements, and the definition of what should be counted as supplements to pay.

First, many forms of pay supplements are only loosely, if at all, related to work effort and consequently do not add to the incentive elements in the compensation system. In fact, by providing family allowances or contributing to health and life insurance schemes, etc., governments predominantly pursue objectives other than productivity. Thus, in general, the basic pay structure is more effective in motivating individuals to perform to the best of their ability, and consequently, if pay supplements, unrelated to performance, become a large proportion of total compensation, it may blunt the incentives that the base salary structure is intended to provide. Insofar as pay supplements are granted from a certain grade upwards, however, non-salary allowances and fringe benefits may motivate an individual to perform well Co obtain a promotion. Conversely, flat-rate pay supplements, such as free Lunches, represent a declining incentive relative to the base pay for those who are promoted or advance up the salary scale.

In fact, pay supplements sometimes create incentives, which are at odds with the compensation system’s objective of promoting productivity in the government sector.

(1) Generous travel allowances exceeding the actually incurred expenses by a wide margin, for instance, create a strong incentive to travel frequently and to leave the business of running the office to one’s subordinate.

(2) Pensions may impose penalties on employees who quit early and this discourages mobility between the private and public sector. In Sri Lanka, for example, the pension scheme is not available for those resigning before age 55 (except on medical grounds). It therefore constitutes a strong incentive to public servants to stay put. ^19/

(3) The provision of government housing at a nominal rent to only a small fraction of those who are eligible (as in Malawi and Zambia), with those not enjoying this benefit being massively disadvantaged, is likely to restrict regional mobility within the government. Furthermore, the system of rationing may become a source of corruption and patronage.

(4) “Project honoraria” (to compensate for the costs of supervision) can create an incentive to maximize capital expenditures, regardless of their economic and social efficiency. In Indonesia, for example, the development budget includes such allocations, with a strong correlation existing between the project honoraria and the aggregate amount of project expenditures.

(5) Loose controls on the payment of overtime can Lead to a slowdown of work effort during normal office hours.

(6) Finally, making arrangements for receiving pay supplements frequently involves non-negligible costs in terms of civil service staff time.

Second, the distributional effects of pay supplements depend on a number of factors. These comprise, inter alia, how the pay supplements are computed, whether their provision is contingent upon the grade of the employee and whether they are provided in cash or in kind.

(1) Only benefits computed as a fixed percentage of an individual’s base salary—and granted across grades—do not alter the internal relativities of the base pay structure, while benefits granted as a flat amount tend to contribute to a compression of the internal pay relativities.

(2) Many forms of pay supplements, such as spouse or children allowances, pensions, or leave policies, are provided independent of the grade. Thus, these supplements tend to be distributed equally across grades and salary levels. On the other hand, in many, especially African, countries, there are pay supplements that are important in terms of value and that tend to favor high ranking employees, comprising, among others, the free or highly subsidized provision of houses and cars. In Malawi, for example, most of those waiting for government-provided housing are employees in the lower grades; employees who succeed in obtaining government housing pay a nominal rent equivalent to 10 percent of their basic pay, while those having to rent a house on the free market forgo any housing benefit. Similarly, in Uganda, only employees in the upper grades are likely to be housed, creating a big pay gap between them and middle level officials.

(3) Also the question of whether pay supplements are provided in cash or in kind may be of importance, particularly in times of high inflation rates. Inflation increases the nominal value of fringe benefits in kind, while supplements fixed in nominal terms (as well as the basic pay) are not affected. Thus, if in-kind benefits account for a large share of total compensation, inflation can change the distributional outcome of government compensation systems considerably. In a number of African countries, for instance, the provision of housing mainly to employees in the upper grades has tended to mitigate the effects of a base pay compression in recent years.

Third, another question is whether benefits in kind are an efficient means of remunerating labor services, both from the employee’s and the government’s perspectives. For the employee, benefits in kind are only to a limited extent transferable into other goods and services. Housing, transportation, medical insurance, annual leave, and other pay supplements represent benefits that are difficult, if not impossible, to convert into other goods and services, restricting the consumption choices of the employee. Thus, only if the benefit in kind provided by the government is exactly the same as the employee would have chosen if he had received his compensation in cash, would the employee be indifferent between benefits in kind and in cash. In all other cases, the consumption bundle of the government employee is sub-optimal. ^20/

For the government, the remuneration of civil servants through the provision of benefits in kind tends to mask the true labor costs of government activities. This hampers a rational policy choice among different benefit programs. In a number of cases, such as free housing, the provision of pay supplements does not lead to outlays and consequently does not show up in the budget. In other cases, such as free lunches or free transportation to and from work, the cost incurred by the government to provide the benefit is recorded in the government accounts. Typically, however, it is not in the wage bill, but under a different heading. Moreover, the budget does not show the benefit as perceived by the government employee, but the cost of providing the benefit. ^21/ Typically, the employee evaluates the received benefit lower than the cost of providing the benefit. Thus, in a more cash-oriented compensation system, the same benefit as perceived by the employee can be provided at lower cost for the government.

In conclusion, as far as benefits in kind are concerned, the budget provides a distorted picture of the wage costs of government activities. They are either completely left out of the budget or shown with an amount that only accidentally corresponds to the benefit as perceived by the employee.

These considerations, both from the employee’s and the government’s perspective, would argue for greater cash orientation in government compensation systems—for the employee to widen his consumer choice and for the government to make optimal use of its scarce resources. Indeed, a number of countries have recently embarked on pay initiatives with a view to minimizing payments in kind. In Botswana, for instance, the Government is currently encouraging civil servants to purchase government-owned houses by granting loans at low rates and is moving to full economic rents on the remaining government houses. Similarly, in Indonesia, Liberia, and other countries, the government sold all official cars to its employees.

Fourth, a final issue is the definition of what should be counted as supplements to basic pay.

(1) So far, no reference has been made to unofficial prerequisites. It is well known, however, that in many countries government jobs provide an opportunity for illicit incomes, such as surcharges on government-provided goods and services or kickbacks on government purchases. Gray (1979) reports that in Indonesia suppliers routinely budget 5–10 percent of total project costs as kickbacks. From a budgetary standpoint, this results in hidden wage costs in the category of expenditure on other goods and services. Clearly, the portion such income supplements account for in the total compensation package differs among countries; furthermore, probably not all of the civil servants are in a position to take advantage of such illegal income sources. ^22/

(2) If the compensation issue is placed in a longer-term context, as is done in the concept of human capital, one could argue for counting not only the basic pay, nonwage allowances, and fringe benefits as compensation for labor services but also the amount of human capital accumulated as a by-product of work activities performed. The acquisition of skills and knowledge improves income prospects at a later stage in the career and thus represents a value that employees are prepared to trade off for other forms of compensation. In the United States and Japan, for example, it is not unusual for capable managers to spend a number of years with the government, despite a comparatively low pay, before joining the private sector. Among other factors, the opportunity of accumulating a substantial amount of human capital and connections while working for the government has been cited as being responsible for such career decisions.

(3) Another facet of the civil service is that it enjoys a high degree of job security, which could also figure in the calculation of broadly defined compensation packages of labor services. In the Federal Republic of Germany, for instance, civil servants cannot be fired (but they do not have a right to strike and have to join the Government before the age of 35). Such nontangible income components, however, are difficult, if not impossible, to quantify.

What lessons for the design of a compensation system can be drawn from this discussion? In general, the base pay system should be the cornerstone of the compensation system, and nonwage allowances and fringe benefits used only to account for special factors that cannot be dealt with by the base pay system. To be clear, what is in question here is not the level of compensation but the structure, that is, how compensation occurs—via the base pay or pay supplements. The base pay system is much easier to administer, more transparent, and tends to be more effective in promoting good performance of government employees. Nonwage allowances and fringe benefits, however, have become entrenched as an important part of the government compensation system in many countries.

As a minimum, policymakers should periodically review their system of pay supplements in terms of adequacy. Generally, in-kind supplements to increase consumer choice of the recipients and to improve the financial control of the government should be abolished. In determining procedures for granting pay supplements, policymakers have to take into account that only supplements calculated as a percentage of the base pay and granted across the board do not affect the internal relativities of the compensation system. Finally, pay supplements, unrelated to performance, should not account for too large a share of total remuneration to preserve the incentive effects the base pay system is supposed to provide. In any case, pay supplements creating perversive effects in terms of productivity should be avoided. ^23/

a. Advancement on a pay scale: seniority vs. merit

There are two methods of moving individuals through a salary scale: seniority and merit. Under the seniority system, an individual progresses up the salary scale attached to his grade quasi automatically by applying certain rules relating the advancement to factors such as age or length of service. Consequently, the rate at which different individuals progress up their pay scale is uniform. Under the merit system, increments on a pay scale are based on performance appraisal results and the speed at which an individual progresses toward the maximum of the pay scale depends on personal performance. ^24/

In developing countries, government pay systems with individual pay increments based on an assessment of job performance are hard to find. In fact, regulations regarding individual pay increments are frequently quite rigid, with pay increases granted quasi automatically to practically all government employees at regular intervals, typically on an annual or bi-annual basis. In a number of countries, however, supervisors have a certain degree of discretion in accelerating or withholding pay increments: additional, increments may be awarded to provide outstanding employees with more rapid progression; conversely, withholding pay increments to penalize poor performers is more rare.

In Mali, for example, depending upon the performance assessment, strong performers can move up by as many as four steps; the number of those who move up by three or four steps is limited to 10 percent of the total staff. For most of the employees, whose performance is presumably satisfactory, however, progress is likely to be uniform; the vast majority moves up by two steps. Penalizing those who are below satisfactory performance by withholding pay increments is used only in exceptional cases. ^25/ A similar pay system is used in Thailand. Each employee in the government sector is virtually guaranteed a one-step pay increase each year. While that is formally called a merit increase, in fact, it has become a seniority increase because it is being given to nearly everyone. Only a modest percentage (about 15 percent) receives a two-step increase based on exceptional merit as perceived by supervisors. A three-step merit increase is extremely rare and requires cabinet approval.

In some developing countries in Africa and Asia efforts have been made to enhance the performance orientation of the public pay system. ^26/ Most important, a number of countries have adopted open reporting systems on employees. The reporting system introduced by the Indian Government in 1978, for instance, included a provision for self-appraisal by the employee. Furthermore, it required supervisors to assess the performance of their subordinates against the background of their duties and responsibilities as well as targets assigned during the reporting year. Finally, the report has to indicate the subordinate’s career potential.

In developed countries, the pay-for-performance component of government pay systems has also been rather underdeveloped until recently. In the Federal Republic of Germany, for instance, individual pay increments are granted every two years, depending entirely upon seniority, while promotions to a higher job grade are used as principal reward for successful performance. ^27/

A government pay system, such as the one in the Federal Republic of Germany, which relies on the prospects of a promotion to a higher grade as the principal reward for good performance, may have difficulty in motivating individuals, should doubts arise about the future availability of the deferred rewards. If, for some reason, the government sector ceases to expand or even shrinks, or if the policy of internal promotion is modified toward more reliance on recruiting senior staff from outside, and consequently the government is unable to deliver on its promised deferred rewards, the motivation of those who feel that past efforts and achievements remain unrewarded will certainly drop considerably.

Among the developed countries, in Great Britain and the United States attempts have been made to enhance the merit component in the public pay system. In Great Britain, the practice of performance-related pay has been spreading into the public sector since the change of government in 1979. These reform efforts are still under way and comprise an overhaul of the pay systems employed by all public sector agencies; the principal objective is to substitute performance as the main determinant for individual pay increases for seniority and to introduce special schemes for compensating senior executives.

In the United States, a merit pay system was established by the Civil Service Reform Act of 1978 for more than 100,000 mid-level managers in job grades GS-13 to GS-15. Under the merit pay system, employees no longer progress automatically up the pay scale every year (as do the employees in job grades below GS-13) but forgo half of the longevity raise for a chance at a higher increase from a merit pay pool.

The new system required departments to set up merit pay systems tailored to their particular needs. The U.S. Navy, for example, developed a system with six evaluation categories; (1) substantially above target on all items; (2) substantially above target on most of the significant items; (3) above target on all significant items; (4) on target on all significant items; (5) on target on most of the significant items; and (6) below target on most of the significant items. The “items” are critical elements of job performance to be spelled out by each agency to each employee. ^28/

Data regarding employee attitudes about performance appraisal gathered by the U.S. Office of Personnel Management suggest that the pay-for-performance system has achieved a high degree of acceptance among employees concerned. Exceptions to this general finding, that is, departments where a majority of the employees believed that the payouts under the new system were unfair, point to general problem areas of a pay-for-performance system. In one case, ratings were too even—with 85 percent of employees concerned rated very high. As a result, payout rates for fully successful employees were quite low and were felt not to sufficiently reward above-average performance. In another case, appraisals were too severe in the opposite direction, with less than 20 percent of ratings given above fully successful. This, too, resulted in a perception of unfairness among employees. ^29/

Reforms of the public sector pay system such as those undertaken by the United States and Great Britain are all motivated by the general belief that a merit-oriented pay system encourages a more competitive and entrepreneurial spirit, which is one of the factors responsible for efficient resource allocation in the private sector; consequently, with a merit-oriented pay system, the public sector will be able to provide public goods and services more efficiently. Giving good performers year after year the same pay increment as everybody else leads them to believe that their contribution has gone unrewarded and they will lessen their efforts. Instead, performance-related pay creates a working climate that encourages everybody to give their best. In sum, merit pay potentially raises the general level of morale and productivity in the government sector.

On the surface, pay-for-performance appears to be an excellent device. In practice, however, there are important barriers which militate against the use of merit pay systems.

First, the civil service is vulnerable to the abuse of political power. This suggests the need to minimize the discretion allowed public managers in rewarding good performers and penalizing poor performers.

Second, in many sectors of the government team effort is paramount, leaving little room for performance-related pay. Reflecting this, the armed forces, the judiciary, and the foreign service have so far been excluded from the reforms in Great Britain.

Third, many jobs (both in the private and the public sector) allow for differentiation in performance only to a very limited extent, in particular, at the lower grades. Frequently, employees hired for a job will be successful once they have learned the basic duties and functions. In this case, there is not much scope for the concept of pay-for-performance. A system under which the employee moves step by step through the. salary range, provided his performance is broadly in line with the performance of other employees, has the advantage of requiring only a minimum of administrative effort and time and does not allow for favoritism.

Fourth, for job positions that allow for greater differentiation in performance, a sound performance appraisal system has to be developed to avoid favoritism from creeping into the appraisal process, lowering morale and efficiency. It has been found that a successful merit pay system has to meet at least the following three preconditions;

(1) There must be a method of measuring performance. This implies that standards have to be developed against which the output of a civil servant will be measured. To base the performance system on a measurable and quantifiable outcome is already difficult in the case of the production of private goods for which there is a market. It is even more difficult for the provision of public goods. Inevitably, judgment is a factor playing an important role in the appraisal of performance. To minimize the possibility of misjudgments, the appraisal system consequently has to include a system of checks and balances in which several judges make independent performance assessments. This can go a long way toward reducing bias.

(2) The method must be fair and equitable and provide for consistency between individuals with similar and different performance.

(3) Finally, the system should be straightforward and simple to administer. It must not become a paper-intensive nightmare.

In any case, if a government leans toward a merit-oriented pay system for civil servants, it should take into account the following:

(1) Performance management has to be learned; thus the implementation of a merit pay system will take time. It has been suggested that there is at least a three-year implementation cycle.

(2) Public sector managers have to devote time and effort to ensure effective performance management.

(3) Individual motivation does not depend only on material incentives. Recent trends in developed countries toward humanization of the workplace suggest that it has been realized that nonmaterial factors are also encouraging individuals to give their best.

(4) The pay system has to be adapted to the societal setting in a country. In Japan, for instance, there is less emphasis on the individual than the group; cooperation with others is valued more highly than self-interested, individualistic behavior; clearly, in such a society, there is less room for linking pay and performance. In general, the application of performance-oriented pay systems, which have proven to be effective in Western countries, requires considerable tailoring to make them fit local cultural realities. ^30/

In conclusion, governments should move gradually and adopt an experimental approach. They should first allow the merit component to play a larger role in the regulations that govern promotion to a higher grade, before strengthening the performance orientation of the regulations that govern individual advancements up a salary scale; furthermore, there tends to be more scope for the application of merit pay in the upper end of the grade hierarchy than in the lower ranks.

b. Compensating top executives

An erosion of the pay Level coupled with a compression of the salary structure has made it difficult in many countries to attract and to retain high Level professionals in the civil service. While a general decompression of the salary structure is one approach to this problem, ^31/ a number of countries have taken a different route by designing special pay schemes for remunerating their staff at the supervisory, professional, and managerial level.

One of these attempts was the creation of a Senior Executive Service (SES) (together with the introduction of merit pay for middle-class managers) in the United States in 1979. The SES is composed of some 7,000 upper-management government employees occupying jobs previously classified as GS-16 to GS-18. ^32/ They no longer enjoy job security and are compensated by a pay-for-performance system, which has three elements: (1) the basic pay system with individual increments based on performance; (2) a system of incentive bonuses (a bonus of up to $20,000 per employee may be awarded to not more than 6 percent of the SES for “sustained accomplishment”); and (3) a system of performance bonuses (a bonus of not more than 10 percent of the base pay may be given to no more than 20 percent of the SES in any agency). Among the top managers eligible for a performance bonus, there is reportedly a general feeling that the quota limiting the performance bonus to one top manager in five is too restrictive; the consequence is that the performance bonus system has become a breeding ground for resentment. ^33/

Roughly half of the government employees in the SES have been hired into their job from outside the government, and it is likely that they will leave the civil service with the next change in administration. This points to an important management issue: Should the civil service be managed by career bureaucrats, who join the civil service early in their career and stay until retirement (as, for instance, in the French and German administrations) or by senior staff for which holding a government job is a step in their career in the private and public sector. Clearly, the SES concept facilitates the flow of ideas and managerial practices between the private and the public sector, but possibly at the expense of dedication and commitment of the senior staff to the civil service. ^34/

In Great Britain, changes in salary policy for senior executives are currently being introduced across the public sector. In the central government, an experimental lump sum merit bonus scheme was established for senior civil servants in 1985. Under this scheme, outstanding performers (the number of which cannot exceed 20 percent of the eligible staff) were to receive a bonus in any one year not lower than £500. As in the case of the performance bonus in the U.S. Government, the limit of 20 percent was felt to exclude and thus demotivate too many high performers. From 1987 on, outstanding performers in the undersecretary grade, who have reached the top of the pay scale, will be able to move into an extended premium range.

At the National Health Service, the Government is in the process of introducing performance-related pay for about 800 general managers. A key feature of the system is the setting of short-term and long-term objectives for each manager, followed by a performance review, to determine the individual pay increase. This can range between no increase (for those who have met few short-term objectives and have made little or no progress toward long-term goals) and an increase of up to 3–4 percent plus the annual general pay adjustment.

Other sectors, where some form of performance-related pay for top executives has been introduced, include local governments and parastatals. At the Post Office, for instance, managers at director level had a choice between staying on their old contract or accepting a new contract, involving the possibility of receiving a merit bonus, the size of which can vary substantially among individuals. A few directors chose to stay on their old contract. ^35/

In developing countries, the possibility of introducing special schemes designed to attract capable managers into the public sector has been considered in a number of countries, including Ghana, Peru, and Bolivia. In Ghana, a special scheme has been adopted under which secondment to government posts from more remunerative positions outside the government sector is currently being financed through a World Bank loan; in Peru, the idea was dropped after the recent change in government; and in Bolivia, the Government has decided to create an elite cadre, trained in special administration schools and remunerated independent of the general public sector pay system.

a. Intragrade and intergrade differentials

As far as the base salary is concerned, differences in pay among individuals can stem from two factors: the grade the individuals are allocated to and the progress they have made on the pay scale attached to their grade. Thus, there are at least two concepts of internal pay relativities: within-grade differentials, that is, the spread between starting salaries and maximum salaries of salary scales; and between-grade differentials, that is, the relative position of salary scales attached to the grade hierarchy, for instance, as measured by the spread between the starting salaries of the lowest and the highest grade.

Within-grade salary differentials serve to remunerate unequally individuals who are occupying similar positions, but have different experience or perform differently. Thus, the spread between the minimum and maximum salary has to be wide enough to provide sufficient room to properly reflect differences in individual performance or experience, or both. Studies of pay systems in the private sector in the United States show that the spread between starting and top salaries is narrower for lower-level positions. Maximum salaries at the lower end of the grade ladder are commonly about 35 percent higher than starting salaries; higher level positions have frequently a 50 percent spread from minimum to maximum salary.

Turning to intergrade relativities, there are a number of factors affecting the “relative pricing” of grades. ^36/ First, as mentioned earlier, the structure of the government’s pay system reflects the government’s equity objectives. For governments preferring an egalitarian income structure, only small differentials between the pay scales attached to the grade ladder in the civil service are a policy objective. Furthermore, in a number of developing countries, the employment of workers at the lower end of the grade ladder has a strong social component. Thus, salaries and wages paid to those employees are not so much intended to compensate for labor services as they are to provide social benefit payments. The level of compensation for those employees is consequently dictated by social objectives, typically without any regard for the labor market situation.

Second, the government has to be able to attract, at all levels of the grade ladder, people to work in the civil service. Consequently, the pay the government offers should reflect supply and demand conditions for labor. Thus, the government has to create a between-grades pay structure, which encourages individuals to remain with the government and to seek a promotion to a higher grade rather than to leave government and to seek alternative employment opportunities in the parastatal and domestic private sector or in the international market. ^37/ The pay structure must provide internal incentives and the pay level must be externally competitive.

Of course, labor market conditions determine only the minimum pay at all grade levels necessary to retain and attract capable individuals to a job; they do not set an upper-bound limit to government pay. Forces to restrain government pay are likely to emanate from the competition for resources within the government sector. These forces are certainly stronger during periods of budget constraint.

Labor market conditions are less important for determining the pay for different grades in the government sector, if private sector demand for a particular type of labor is relatively small or even nonexistent. In the Federal Republic of Germany, for instance, education is largely provided by the Government; there are only a few private schools. Thus, there is no “going rate” for teachers and the government is a factor-price setter rather than a price taker. Generally, competition in the labor market between private enterprises and government is an important determinant for the intergrade relativities in government pay and tends to be of more significance in developed than in developing countries. ^38/

Third, another factor, which is related to the first one, affecting the relative positions of pay scales is the general perception of what constitutes a fair and just reward for a job. This element has particular weight, if there is no “prevailing rate” in the private sector, giving the government guidance in its pay decision, because private sector demand for labor is small or nonexistent. Generally, the level of skills jobs require and the responsibilities they carry are important elements in determining intergrade pay differences. In countries relying on the rank-in-man system for grading positions, the perception of what constitutes fair pay tends to be heavily influenced by the educational requirements for a grade. Consequently, the between-grade dispersions display a strong bias toward the educational qualifications of the job holder.

Fourth, the most frequent reason for reviewing a pay scale is inflation. The revision of the salary structure to compensate for an increase in the cost of living may significantly alter the between-grade pay differences depending upon the method applied to update the salary structure. Related issues are discussed in more detail in the following section.

b. Cost of living adjustments

Inflation does not alter the relationship between pay scales attached to different grades. In nominal terms, the pay scale system is not affected by inflation; in real terms, inflation erodes all pay scales by the same percentage amount. ^39/ However, the updating of the pay scales may significantly affect the internal pay relativities.

There are two extreme ways of general pay adjustments: to increase all pay scales by the same absolute amount or by the same percentage amount. ^40/ Both methods differ sharply in terms of their implications for the internal pay structure. If the original shape of the internal pay structure is to be maintained, adjustments must be made by uniform percentage application. Flat amount adjustments compress the internal pay structure. There are infinite options between these extremes by granting a higher percentage increase to those at the Lower end of the job grade ladder. In general, all formulas but the uniform percentage adjustment result in a compression of both the between-grade pay dispersion and the within-grade dispersion.

General salary adjustments that compress the pay scale system have been a feature of government pay policies in many developing and developed countries in recent years. In some countries, it was a conscious effort to “narrow the gap”; in others it was felt to be the only way of reconciling a tight budgetary position with social objectives. Frequently, the policy of compressing the pay structure exacerbated the problem of a decline in real terms in the level of pay.

In Senegal, for example, there were three pay scale system updates between 1980 and 1985. All were adjustments by absolute amounts rather than uniform percentage adjustments. ^41/ Appendix Tables 4 and 5 show trends in basic starting salaries and in ratios between higher and lower paid grades in selected African countries for the period 1970–83: there has been a compression of the pay stales of civil servants in all of the countries included in the sample, with the compression being most pronounced in Zambia and Nigeria. In Zambia, undersecretaries were paid in 1983 seven times as much as the lowest-salaried employee, compared with a ratio of 20:1 in 1971 and 15:1 in 1975. In Nigeria, the basic pay of a permanent secretary in 1975 was 17 times that of an unskilled worker; since 1983, it has been only 9 times as much.

Compression of the government pay scale system is not a phenomenon confined to developing countries. In the U.S. civil service, for example, the top officials have suffered a loss in the purchasing power of their base salaries of about 40 percent between 1969 and 1986, compared with only a few percent for the lower-paid members of the civil service. ^42/ This has partly been the consequence of the imposition of “caps” on the pay scales in the upper range of the grade ladder, as a result of which in 1980 and 1981, for instance, the maximum salaries of the pay scales of the six SES grades were exactly the same. ^43/

According to a recent World Bank interim review of its experience in public employment and pay reform, in 6 countries out of the 30 in which the Bank has currently a lending program that includes a public employment or pay component, compression of the salary scale in the public sector has reached proportions diagnosed as a major problem for the country. These comprise Bangladesh, Guinea, Guyana, Jamaica, Peru, and Thailand. ^44/

It is important to point out, however, that the perception of a compression in the government pay structure is typically based on the starting or maximum salaries of the pay scales attached to the grade system and consequently leaves out two elements that are important for the compensation of individuals.

First, inflation does not lead to an erosion of the noncash portion of pay supplements. Thus, in a number of developing countries where noncash pay supplements, such as housing, are important and tend to benefit employees in higher grades relatively more, the recent compression in the base pay system was somewhat mitigated by sizable (nominal) increases in noncash salary supplement. Furthermore, a tight policy with respect to the base pay may result in a more liberal granting of other pay supplements as well as intensified efforts on behalf of the employees to augment their pay. In Israel, for example, the number of employees receiving car allowances grew almost five times as fast as the number of civil servants between 1974 and 1978, when a policy of wage restraint kept the general pay adjustments to small increases. ^45/

The second factor is that an individual’s base pay is not only affected by general revisions of the pay scale system but also by his progression through the pay scale system. Consequently, the formal development of the relative positions of pay scales over time does not reflect within-grade progression and promotions of individuals as well as regrading of jobs. In many countries, it has been observed that the imposition of constraints on updates of pay scales has been circumvented by on increase in numbers promoted to higher grades (promotion drift) or a regrading of jobs (grade creep). Thus, promotions and regradings have been a means of individually granting salary increases beyond those provided for by the general revision of the pay scale system. This, for instance, occurred in Ethiopia, where between 1975 and 1981, general salary adjustments were limited to government employees earning less than Br 285. Not surprisingly, the annual number of promotions more than doubled during this period. Moreover, in 1982, one out of five jobs vas regraded. Similarly, in Israel, during the 1974–78 wage restraint period, the number of promotions a year exceeded 40 percent of the total staff, compared with less than 20 percent in the 1960s.

A number of governments, finding it difficult to recruit and retain employees at the upper end of the grade ladder, have recently undertaken policy initiatives to adjust selectively the pay scale system with a view to decompressing the base salary structure. ^46/

In Ghana, for instance, a policy of protecting the real salaries of relatively unskilled workers by granting larger percentage increases for those at the bottom end of the grade system resulted in a decline in the ratio of the salaries of the highest and lowest paid civil servants to 2:1 in 1985. This was considerably out of line with the typical 10:1 differential prevailing in the private sector. In an effort to restore the viability of public administration, the authorities adjusted the public service salary structure in 1986 with a view to restoring the ratio between top and bottom salaries to almost 6:1. The changes also included a substantial increase in the daily minimum wage and were supported by reduced tax rates on personal incomes. In Sri Lanka, selective salary increases in 1986 Led to a decompression of top to bottom salaries to 11.8:1, compared with a ratio of 4.2:1 in 1984. finally, in Jamaica, faced with high vacancy rates in key ministerial posls, the Government initiated a pay reform in 1984 with a view to raising in steps high-level grade salaries in the civil service to 35 percent of those in the parastatal sector. Although several selective pay increments were effected, indications are that the pay for high-level civil servants did not reach the 85 percent parity with the parastatal salary level. As for developed countries, in the United States, the 1987 budget provided for a general pay increase substantially above average for top government employees. Nevertheless, the pay adjustment fell far short of the increases (varying from 55 percent to 75 percent) recommended by the Commission on Executive, Legislative, and Judicial Salaries to bring salaries in the top ranges of the Government in line with the private sector.

With regard to the administrative arrangements to update the pay scales system, in many countries the public sector pay system is subject to reviews by public service salary commissions, frequently on a regular basis. This has in some cases resulted in the pay scales system being unadjusted for a number of years and subject to what might appear a large increase in nominal terms, although, in real terms, salaries may be still below past levels. The pay tribunal in Nigeria, for instance, reviews remuneration in the light of inflation only every three to five years. In the same way, the Dominican Republic typically makes general pay adjustments every five years. Other countries, particularly those with high inflation rates have preferred more automatic modes of updating the public sector pay scales by adopting indexation schemes. ^47/ If the indexation formula provides for a uniform percentage increase across the board, nominal indexation of salaries does not alter the internal relativities. Only partial compensation for inflation and the time lag involved in updating the pay scale system, however, have frequently led to an erosion of the pay level; furthermore, a number of countries have adopted indexation formulas, which resulted in a compression of the salary scale system.

In Brazil, for instance, the various indexation formulas applied in recent years typically did not provide for a uniform percentage increase. Instead, salaries were segmented into brackets and only the lower brackets were fully indexed, while the percentage increases applied to higher brackets became progressively smaller. In Italy, up to 1986, the indexation arrangement provided for fixed lira amount adjustments per point of change in the cost of living index.

In high inflation economies, such salary indexation schemes can rapidly produce a severe compression of the salary structure. In general, however, salary indexation is considered to be less of a problem in terms of internal pay differentials but has often been held responsible for the acceleration of inflation by maintaining a price-wage spiral. In addition, such schemes have frequently slowed necessary adjustments to real wages in response to movements in the underlying real variables of the economy, such as shifts in the terms of trade.