Government Pay Policies and Structural Adjustment

The paper provides an overview of the main elements of pay systems that are typically used to remunerate government employees and, with reference to the experience of developed and developing countries, discusses structural issues frequently arising in the formulation of government pay policies: (1) the role of fringe benefits in the compensation system; (2) the pros and cons of a greater merit orientation in the pay system and of special pay schemes designed to remunerate staff at the professional and managerial level; and (3) factors determining internal pay differentials with special emphasis on the compressing effect of flat amount cost of living adjustments.


The paper provides an overview of the main elements of pay systems that are typically used to remunerate government employees and, with reference to the experience of developed and developing countries, discusses structural issues frequently arising in the formulation of government pay policies: (1) the role of fringe benefits in the compensation system; (2) the pros and cons of a greater merit orientation in the pay system and of special pay schemes designed to remunerate staff at the professional and managerial level; and (3) factors determining internal pay differentials with special emphasis on the compressing effect of flat amount cost of living adjustments.

I. Introduction

The government wage bill has come under scrutiny as a factor contributing to an overall fiscal problem in many member countries. In fact, targets for government employment and wages have been important elements in many adjustment programs supported by the Fund in recent years. During 1980–84, for instance, restraint of government wage and salary expenditure was a policy adopted in about two thirds of the Fund-supported adjustment programs undertaken during this period. 1/ These efforts to keep the government wage bill in check took a number of different approaches, including the freezing of employment levels and the limiting of general pay increases.

Typically, the policies were inspired by what Tanzi has coined the macroeconomic approach to stabilization policies. 2/ The main policy objective was to ease demand pressures emanating from the public sector. 3/ Thus, the emphasis of government pay and employment policies has been more on keeping the government wage bill in check rather than on promoting reform of public employment and pay policies to make the public sector more productive. More recently, however, the Fund has been attaching increasing importance to specific policy changes. This shift in emphasis has been accelerated since the establishment of the structural adjustment facility, which calls for greater involvement of the Fund staff in the structural aspects of economic policies of member countries. This paper contributes to this development, by discussing important structural issues frequently arising in the formulation of government pay policies.

The paper is organized as follows. Section II briefly discusses the three key structural issues that need to be addressed by policymakers with respect to pay and productivity in the government sector: the balance between personnel and other expenditures (such as those for supplies and maintenance); the balance between the number of employees and their pay level; and the establishment of a pay system that is conducive to good performance of government employees. Section III is a brief description of the five main building blocks of pay systems that are typically used to remunerate government employees: a hierarchy of grades, salary scales attached to the various grades, regulations governing an individual’s progression up the pay scale, regulations governing promotions, and a system of nonwage allowances and fringe benefits. Section IV examines three important structural aspects of pay systems in greater detail. First, there is a discussion of the role of nonsalary allowances and fringe benefits in compensation packages. Second, there is a review of problems associated with achieving greater merit orientation in government pay systems and of efforts to create special pay schemes for remunerating staff at the supervisory, professional, and managerial level. Third, a review of factors determining internal pay differentials with special emphasis on the effects of cost of living adjustments concludes the section. Section V summarizes the paper’s main findings.

II. Government Pay Policies: Demand and Productivity Effects

Like other outlays for goods and services, the government wage bill is a component of aggregate demand. Any expansion in aggregate spending sets in motion a multiplier process, affecting the private demand for domestically produced goods, as well as imported goods. Additional spending on imported goods contributes to a worsening of the balance of payments while having no effect on domestic output. Thus, government pay is an important factor in the management of aggregate demand.

The government, however, not only contributes to domestic demand but also to domestic production. It produces “public goods,” which are typically provided free of charge to the private sector. (Thus, there is no market price for public sector output and the public sector cannot have its pay determined by forces emanating from the output market.) 4/ Public goods may be either consumed by the private sector or used as inputs in private production. Insofar as they are consumed by the private sector, public goods compete with privately produced goods and tend to decrease the productivity of the private capital stock. Conversely, public goods that are beneficial to production lower private costs and increase the productivity of the private capital stock. Thus, depending on the nature of the goods and services provided by government employees, government outlays on wages and salaries can stimulate private production and growth, or only add to the consumption (and welfare) of private households without any impact on private sector output and growth.

Independent of the issue of whether the goods and services provided by government contribute to improving productivity and accelerating growth in the private sector, policymakers have to make decisions regarding the conditions under which these public goods and services are produced. What is in question here is not what kind of goods and services are provided by the government, but the efficiency with which these goods and services are produced. Thus, government pay policies not only are a critical element in the macromanagement of aggregate demand and supply but also have important ramifications for the efficient use of scarce resources in the public sector. Any demand-oriented adjustment effort in government pay must therefore not lose sight of productivity in the public sector.

Three structural issues at least need to be addressed by policymakers in this regard: (1) the balance between personnel expenditures and other government expenditures (such as those for supplies and maintenance); (2) the balance between the number of employees and the level of their pay; and (3) the establishment of a pay system that is conducive to good performance of government employees.

First, the output of an organisation like the government is a function not just of the number of employees and their productivity, but also of the interplay between labor and the other two main inputs—materials and capital—into an organization. For instance, the efficient production of the public good “education” implies certain amounts of resources devoted to salaries (teachers), but also to investment expenditures (school buildings) and expenditures on other goods and services (books, papers, etc.). Faced with financial problems, governments have frequently resorted to keep expenditure in check by reining nonwages. This has often resulted in personnel remaining on the payroll but unable to perform their duties in a timely and cost-effective manner because of a lack of complementary inputs.

Examples abound for the paucity of complementary inputs in producing government services in countries experiencing financial difficulties: teachers without books and chalk, health personnel lacking drugs and supplies, and agricultural extension workers without transportation. In the Central African Republic, the ratio of personnel costs to other purchases of goods and services rose from 2.8:1 in 1976 to 4.3:1 in 1984, exacerbating the difficulties in providing efficient public services; particularly out of balance became the expenditure structure in the Ministry of Rural Developments, where in the early 1980s, the share of wages in total recurrent expenditure exceeded 95 percent. 5/ What is required in such circumstances in terms of policy actions is an effort to improve the expenditure mix in the budget toward more materials and supplies at the expense of personnel expenditures. 6/

Second, personnel expenditures are made up of two factors: the number of employees and their pay. Although some governments in developing countries have been relatively prudent in their employment policy, others have tended to expand government employment rapidly in recent years. Frequently, expanded employment has been accompanied by the erosion of remuneration in real terms. 7/ Lindauer, Meesook, and Suebsaeng (1988) have analyzed the trends in government compensation for several countries in Africa from the early or mid-1970s to 1983. They found that during this period the compensation of government employees in real terms declined in all of the countries included in the sample. In Sudan, for instance, real wages in the government sector fell 11–15 percent annually between 1975 and 1983. In Uganda, they fell by one fifth to one third each year over this period. 8/ While a fall in the compensation of employees in real terms is often an important element in the required adjustment in the government sector to overcome a balance of payments crisis and to promote growth, there are limits for cuts in the government pay level. For a number of countries, these limits appear to have been reached or even exceeded in recent years. In cases like Sudan and Uganda, for instance, the sharp drop in the level of remuneration has not only resulted in difficulty for the government to attract and retain capable manpower but has also encouraged, if not compelled, those not finding a job outside the government sector to pursue activities at odds with their official duties. Increasing corruption, moonlighting, and chronic absenteeism all indicate that under such pay conditions less and less effort is being devoted to performance on the job and more and more to seeking an additional income source to supplement the diminishing official compensation. For example, in Uganda in the early 1980s, estimates for the time spent by a civil servant in the office ran between one third and one half of the total working hours. 9/

A pervasive irony characterizes this group of countries: while the total government wage bill is too high, the individual compensation is too low. Given financial constraints, the only solution is a reversal of the ill-conceived policy orientation of restraining compensation and maximizing job creation in the government sector.

Countries have followed different routes to tackle the employment problem in the government sector. 10/ A measure involving only minimal political costs has been the elimination of “ghost employees.” Such employees receive a government paycheck but either do not exist or are not employed in the position for which the paycheck is issued. In Guinea, for example, 90,000 people were on the government payroll in the early 1980s, of which almost 10 percent were identified as ghost employees. In the Central African Republic, the development of a verified payroll roster was utilized to remove almost 5 percent of ghost employees from the payroll in 1984 under a World Bank technical assistance project. Also, the policy of firing “temporary” workers (which, for example, has been pursued in The Gambia and Jamaica) does not require extraordinary effort because they do not have the same right to tenure and pension as permanent staff. Several countries have experimented with early retirement schemes. In Togo, for instance, the retirement age was lowered from 55 to 50 years of age or 30 years of service. In a number of cases, however, these schemes did not have a meaningful financial impact, because the schemes merely resulted in a substitution of severance and pension payments for salary payments. In Nigeria, for instance, it can take up to six years to recoup the costs of retrenching a civil servant with 25 or more years of service.

Frequently, countries have resorted to hiring freezes. In the Central African Republic, the hiring freeze introduced under a Fund-supported arrangement was implemented with some degree of flexibility. New hiring was allowed insofar as a ratio of one franc of additional expenditure resulting from the hiring to three francs of savings from a reduction in the number of employees was respected. Another method used to contain government employment was the discontinuation of hiring guarantees for university or public school graduates. This guarantee has recently been eliminated by a number of African countries, including Rwanda (1984), Central African Republic (1983), Togo (early 1980s), Mali (early 1980s), and Sudan (between 1974 and 1981). In other countries, including Côte d’lvoire and Senegal, the number of students allowed to enter university or public administration school was reduced and the hiring guarantee maintained.

Third, the structural features of the compensation system have to be such that they promote efficient use of scarce resources in the government. To maximize the output of government goods and services with a given amount of input, government pay policies must be geared towards pay conditions conducive for good performance of government employees—not only with respect to the level of compensation, but also with respect to the structure of the compensation system. Policymakers have to address a number of issues in this respect, but the following three are paramount: (1) the role of fringe benefits and other pay supplements in the compensation system; (2) the link between pay and performance; and (3) the internal relativities of the pay system, which, inter alia, are affected by the way the pay scales are adjusted for inflation. These three structural issues are discussed in Section IV, following a brief description of the main building blocks of pay systems that are typically applied to remunerate civil servants.

III. Features of Government Pay Systems

A pay system comprises rules and procedures that determine the entitlements of employees to the diverse forms of compensation. Typically, five basic elements constitute a government pay system: 11/

(1) A hierarchy of grades, within which each civil servant is allocated to a grade. Frequently, various grades are classed into a category.

(2) Salary scales attached to the various grades, which determine the range of an individual’s base salary.

(3) Regulations that govern an individual’s advancement up the pay scale attached to his grade.

(A) Regulations that govern an individual’s progression to a higher grade (promotion).

(5) A system of allowances and fringe benefits, which supplement an individual’s basic pay.

First, government pay systems are typically based on a hierarchy of 15–20 grades. There are essentially two approaches of allocating individuals to a grade, the rank-in-man system and the rank-in-job system. In the rank-in-man system, the grade of an individual is largely determined by formal characteristics of the individual, such as education and length of service; in the rank-in-job system, the grade to which an individual is allocated reflects the content of the job held. In practice, rigorous adherence to one approach is rare; most government pay systems incorporate elements of both approaches, although usually one approach dominates.

In the rank-in-man system, the grade is characteristically a title assigned to the civil servant and is only Loosely related to the content of the job he is holding. This system has its origin in the European civil service and has been widely adopted outside Europe. In Senegal, for example, the civil service is made up of 18 grades classed into 5 categories, each differentiated by educational requirements. 12/

The cornerstone of a rank-in-job system is a job evaluation scheme that establishes a hierarchy of jobs on the basis of a systematic analysis of their content, A number of such schemes have been developed and applied. In the U.S. Postal Service, for example, a point system is used to determine the grades of about 80,000 white-collar employees, based on the content and requirements of a job in terms of four factors: know-how, problem-solving ability, accountability, and working environment. 13/ In the process of job grading, jobs are assessed on how much of each factor they contain. Points are then assigned for each factor, a total point score is produced for each job, and finally the point score is translated into a grade.

The rank-in-job system has a long tradition in Australia, Canada, and the United States. 14/ In the last twenty years, a number of governments in developing, including Asian, countries have adopted the rank-in-job system. Though in the traditional societies of Asia, where people tend to be stratified into classes according to their age, birth, knowledge, wealth, etc., the idea of personal rank is rigid, Korea, the Philippines, and Thailand have introduced the rank-in-job system. In Japan, however, efforts to install the rank-in-job system failed and its implementation has been postponed indefinitely. 15/

The grading system has important repercussions on the productivity of the civil service. Generally, by basing the grading of individuals on what they are and what they could do (and not what they are doing), the rank-in-man system provides the government with greater flexibility in allocating employees to different jobs, because their grade and base pay is not affected by a transfer. Also, by emphasizing educational and other formal qualifications, the rank-in-man system encourages individuals to obtain additional training to qualify for higher grades. At times, however, this has resulted in the government Losing some control of the grade structure and of the costs of its work force, especially when the possession of a formal qualification carried an automatic entitlement to promotion. The civil service then becomes overqualified. The rank-in-job system tends to be more conducive to productivity, since it encourages people to perform well in order to demonstrate that they are qualified to take on jobs with a higher content and a higher grade. The application of the rank-in-job system, however, is not easy. The system is time consuming, expensive to administer, complex, and requires a fair amount of personal judgment. Among the critical issues are the quantitative measurement of the job evaluation factors and the determination of the relative weight accorded them.

Second, the system of salary scales attached to the hierarchy of grades provides the base for determining the first source from which public servants’ emoluments flow. It establishes a salary range for each grade, between a minimum and a maximum base salary. Very rarely is a single salary rate in lieu of a salary range attached to a grade. An overlap of salary ranges indicates that an experienced person at the top of his salary range may be of more value to the organisation than a new appointee at the lower end of the grade above. In many countries, the salary scales are divided into different steps. In Thailand in 1985, for example, there were a total of 53 steps with the increase in pay per step varying from 4 to 6 percent. In the U.S. civil service in 1987, each salary scale was divided into 10 steps, with the base salary increasing by 3 percent per step.

Third, while the pay scales determine the range of the base salary for an individual, there also have to be regulations for an individual’s advancement up the pay scale. In government pay systems individual increases are commonly awarded more or less automatically at regular intervals, often every two years. Less frequently, these personal increases are individually determined in the light of an assessment of the individual’s performance. Attempts to increase the merit orientation of the government pay System have been made in several countries; they are discussed in more detail in Section IV.2.

Granting individual pay increases on a regular basis builds an element of automaticity in the growth of the wage bill. In Senegal, for instance, individual step advancements account for 3–4 percentage points of the annual growth in the wage bill. This growth factor appears to be representative for many countries and has to be taken into account in the formulation of pay policies. Accordingly, in Côte d’lvoire, between 1983 and 1984, civil servants had to forgo not only any general pay increase but also the individual pay increase in an effort to limit the growth of the government wage bill, though they continued to progress up the pay scale. When the pay freeze was lifted in 1985, civil servants were paid according to their actual position in the salary scale attached to their grade but were not retroactively compensated for income lost in the pay freeze period.

Fourth, promotion is defined as progression to a grade with a higher pay scale. Like an advancement on a pay scale, promotion to a higher grade may be determined by seniority or may be a way of rewarding good performance. If seniority is an important factor, then a promotion is in effect only an extension of a pay scale. In many countries, however, the performance component has a large weight in the promotion system; frequently, the prospect of future promotion is the main way of rewarding good present effort and achievement. In some countries it has been observed that at times when pay restraints have been imposed on the civil service, promotion has been a means of circumventing tight controls of salary scales. Only modest general salary adjustments have led to an increase in numbers promoted to higher grades (promotion drift).

It should be noted that pay increases stemming from a promotion to a higher grade, as well as individual pay increases due to an advancement on an unaltered pay scale, have to be distinguished from general pay increases, across grades, awarded on cost of living or other grounds, such as changes in the labor market. In the case of a general pay increase, the system of pay scales is shifted upward while in the former case, individuals advance on an unaltered salary scale or move from one salary scale to the next higher one.

The compression of the salary structure recently experienced by many governments is often a direct consequence of the way the system of pay scales has been updated to compensate for inflation. Internal salary relativities remain unchanged only if all pay scales are adjusted by the same percentage amount. An increase of all pay scales, however, by the same absolute amount or, more general, a lower percentage increase for the higher grades leads to a compression of the salary structure. This is what has happened in many countries in recent years, thereby weakening the government’s ability to attract and retain qualified personnel at the middle and high levels. These and other issues pertaining to internal pay differentials are discussed in Section IV.3.

Fifth, in addition to the basic salary determined by the grade and the attached pay scale, civil servants may receive various nonwage allowances and fringe benefits. A wide range of indirect forms of remuneration exist! (1) nonwage allowances such as those for spouse and children; (2) deferred payments, such as pension provisions; (3) contingent payments, such as special performance bonuses; and (A) benefits in kind, for example, free housing. In many countries, pay supplements account for a large part of the total compensation package of a civil servant.

Indeed, to correctly evaluate government pay policies, one has to take into account not only the basic pay but also the nonsalary components. They may have distinctively different economic implications than the basic pay. For example, the noncash elements of pay, such as free housing, are not reduced by inflation (in real terms), as the basic pay is. Furthermore, pay supplements can create incentives, which are at odds with the objective of promoting productivity in the provision of government goods and services. These and other issues related to pay supplements are discussed in Section IV.

In sum, a government employee may receive an improvement in his compensation from four sources: (1) an advancement on the pay scale attached to his grade; (2) a general upward revision of the system of pay scales; (3) a promotion to a higher grade or a regrading of his job; and (4) an improvement in the nonsalary portion of his compensation. These elements of a pay system—grades, pay scales, pay supplements, and the regulations governing advancement on a pay scale and promotion to a higher grade—are not unrelated to each other but must be regarded as an interconnected set of relationships. Therefore, policymakers have to keep in mind that the imposition of a constraint on one element may trigger adaptive reactions elsewhere in the system. Not allowing for a general pay increase, for example, may result in more promotions, offsetting the savings from the freeze in the pay scales. Thus, to be effective, pay policies must always encompass all elements of the pay system.

IV. Structural Aspects of Government Pay Systems

1. Nonsalary allowances and fringe benefits

In addition to the base salary, the compensation of a civil servant typically comprises a number of nonsalary allowances and fringe benefits.

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).

Chart 1.
Chart 1.

Classification of Pay Supplements

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

(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/

2. Pay and performance

The compensation system affects the productivity of government employees through different channels. One important channel, the link between pay supplements and performance, has been discussed in the previous section. This section examines the mechanisms employed in government pay systems to move individuals up the salary scale attached to their grade and reviews the experience with special pay schemes designed to attract and retain high level personnel.

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.

3. Internal pay differentials

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.

V. Concluding Remarks

Government pay policies have important implications not only for aggregate demand, but also for efficiency and productivity in the civil service. The latter aspect of government pay policies has received growing recognition in recent years, in many countries prompted by the pressure of budget constraints on the government wage bill, while at the same time government employment continued to expand.

The assessment of what pay is proper for civil servants should not be based on the narrow concept of the basic salary. In many countries, pay supplements account for a large part of the total compensation package in the government sector. Pay supplements may have distinctively different economic implications than the basic salary. For instance, insofar as they are provided in kind, they are insulated against a real erosion through inflation. As for their incentive effects, many forms of pay supplements are provided independent of performance. Moreover, not unusually, pay supplements create perverse incentives in terms of productivity. Thus, in general, the basic pay structure is more effective in motivating individuals to perform to the best of their ability. Also, benefits in kind are difficult, if not impossible, to convert into other goods and services, limiting the consumer choice of the recipient, and frequently do not lead to budgetary outlays, complicating rational policy decisions. These and other considerations would argue for a pay system with the basic salary structure being the main component, complemented by a cash-oriented pay supplement system to account for individual factors not captured in the basic salary system.

In government pay systems, individual pay increases are typically awarded more or less automatically at regular intervals with only a loose link to performance. In recent years, attempts have been made in a number of countries to strengthen the merit orientation of the government pay system. Although a merit pay system may be at first sight more attractive than a pay system based on seniority, there are a number of barriers that militate against the use of merit pay systems. Most important, universally accepted criteria to measure performance have to be established; otherwise, favoritism is bound to creep into the appraisal process lowering morale and efficiency. A system of checks and balances in which several judges make independent appraisals can, however, go a long way toward reducing bias. In any case, the pay system has to be adapted to the societal setting in a country and the local cultural realities.

The most frequent reason for updating a government salary scale system is inflation. If the original shape of the pay structure is to be maintained, it is necessary that adjustments be made by uniform percentage application. All other methods, such as adjustments by flat amounts, lead to a compression of the internal pay structure. This has been a feature of government pay policies in a large number of countries in recent years. In some countries, it was a conscious effort to “narrow the gap.” In general, it has posed a constraint on governments’ ability to attract and retain qualified personnel in the middle and upper range of the salary scale system. Partly in response to this, some countries have designed special pay schemes with a view to delinking the pay of high Level professionals in the civil service from the general civil service pay scale system.

Finally, the different elements that make up a government pay system—grades, pay scales, pay supplements, and the rules governing advancement on a pay scale and promotion to a higher grade—are not unrelated to each other but must be regarded as an interconnected set of relationships. Thus, pressure on one element may trigger adaptive responses elsewhere in the system. A cut in the basic pay, for instance, may result in pressures on the number promoted, regrading of jobs, or less restrictive granting of pay supplements, offsetting the savings from pay cuts. This may explain why specific measures to contain the wage bill have often not produced the expected results. Consequently, to be effective, pay policies must always encompass all elements of the pay system.


Table 1.

Senegal: Civil service Wage Bill, 1982 and 1984

article image

Principal Allowances Received by Civil Servants, December 1984

(In millions of francs a month)

article image
Source: Bloch, P.L., “Wage Policy, Wage Structure, and Employment in the Public Sector of Senegal,” CPD Discussion Paper No. 1985–41 (Washington: World Bank, 1985).
Table 2.

Nonsalary Allowances and Fringe Benefits in Government Pay Systems in Selected African Countries

article image
article image
article image
Source: Lindauer, D.L., O. Meesook, and P. Suebsaeng, “Government Wage Policy in Africa: Some Findings and Policy Issues,” Research Observer (January 1988), pp. 1–25.
Table 3.

Housing Benefits for Government Employees and Base Pay

article image
Sources: Report of the Malawi Civil Service Review Commission (1985); and Meesook, 0., D.L. Lindauer, and P. Suebsaeng, “Wage Policy and the Structure of Wages and Employment in Zambia,” CPD Discussion Paper No. 1986–1 (Washington: World Bank, 1986).
Table 4.

Salary Compression in Selected African Countries, 1970–83

(Changes in real GDP in percent)

article image
Source: Lindauer, D.L., O. Meesook, and P. Suebsaeng, “Government Wage Policy in Africa: Some Findings and Policy Issues,” Research Observer (January 1988), pp. 1–25.
Table 5.

Trends in Real Base starting Salaries in the Public Sector in Selected African countries 1975–83


article image
sources: Lindauer. D.L.O Messook, and p.suebsaeng, “Government wage policy in africa: some findings and policy issues,” Research Observer(January 1988), pp.1–25.


  • Bloch, P.L., “Wage Policy, Wage Structure and Employment in the Public Sector of Senegal,” CPD Discussion Paper No. 1985–41 (Washington: World Bank, 1985).

    • Search Google Scholar
    • Export Citation
  • Carow, R., “Total Compensation Comparability in the Evolution of Federal Compensation Policy,” in Public Sector Labor Markets,” ed. by P. Mieszkowski and George Peterson (Washington, 1981).

    • Search Google Scholar
    • Export Citation
  • Causey, M., “Merit Pay Systems are Taking Shape,” The Washington Post (February 27, 1980).

  • Diamond, J., and C. Schiller, “Government Arrears in Fiscal Adjustment Programs,” Finanzarchiv (forthcoming, 1988).

  • Ebrill, L.P., “Nominal Indexation of Taxes, Wages, and Bonds,” Finance and Development, Vol. 22 (September 1985), pp. 4244.

  • Gray, C., “civil Service Compensation in Indonesia,” Bulletin of Indonesian Economic Studies, Vol. 15 (March 1979), pp. 85113.

  • Harris, John R., E. Andoh, K. Evlo, and M. Starr, “Experiments in Wage-Bill Containment in Africa” (unpublished, Washington: World Bank, 1987).

    • Search Google Scholar
    • Export Citation
  • Hartman, R.W., and A.R. Weber, eds., “The Rewards of Public Service, Compensating Top Federal Officials” (Washington, 1980).

  • Heller, P.S., “Analyzing and Adjusting Government Expenditures in LDCs,” Finance and Development, Vol. 22 (no. 2, 1985), pp. 25.

  • Heller, P.S., and A.A. Tait, “Government Employment and Pay: Some International Comparisons,” IMF Occasional Paper, No. 24 (Washington: International Monetary Fund, 1983).

    • Search Google Scholar
    • Export Citation
  • Heller, P.S., and Joan E. Aghevli, “The Recurrent Cost Problem: An International Overviewin Recurrent Costs and Agricultural Development, ed. by John Howell (London: Overseas Development Institute, 1985), pp. 2249.

    • Search Google Scholar
    • Export Citation
  • Hofstede, G., “Motivation, Leadership, and Organization: Do American Theories Apply Abroad?Organizational Dynamics, Vol. 9 (No. 1, 1980).

    • Search Google Scholar
    • Export Citation
  • International Labour Office, “Methods of Wage Determination in the Postal and Telecommunications Sector” (Geneva: ILO, 1984).

  • International Monetary Fund, “Fund-Supported Programs, Fiscal Policy, and Income Distribution,” IMF Occasional Paper, No. 46 (Washington: International Monetary Fund, 1986).

    • Search Google Scholar
    • Export Citation
  • Lardeau, Leenhardt, Martin, and Thibault, “Employment and Salaries in the Civil Service in Mali” (manuscript, Paris, Société d’Etudes pour le Développement Economique et Social, 1985).

    • Search Google Scholar
    • Export Citation
  • Levine, Charles H., and Rosslyn S. Kleeman, “The Quiet Crises of the Civil Service: The Federal Personnel System at the Crossroads,” Occasional Paper No. 7 (Washington: National Academy of Public Administration, 1986).

    • Search Google Scholar
    • Export Citation
  • Lindauer, D.L., “Public Sector Wages and Employment in Africa: Facts and Concepts,” Studies in Employment and Rural Development No. 68, (Washington: World Bank, 1981).

    • Search Google Scholar
    • Export Citation
  • Lindauer, D.L., O. Meesook, and P. Suebsaeng, “Government Wage Policy in Africa: Some Findings and Policy Issues,” Research Observer (January 1988), p. 125.

    • Search Google Scholar
    • Export Citation
  • McGrath, James P., “The Senior Executive Service (SES): Morale and Staffing Problems—A Brief Overview” (Washington: Congressional Research Service, 1987).

    • Search Google Scholar
    • Export Citation
  • Malawi Civil Service Review Commission, Malawi (1985).

  • Meesook, 0., D.L. Lindauer, and P. Suebsaeng, “Wage Policy and the Structure of Wages and Employment in Zambia,” CPD Discussion Paper No. 1986–1 (Washington: World Bank, 1986).

    • Search Google Scholar
    • Export Citation
  • Mettelsiefen, B., L. Pelz, and B. Rahmann, “Verdienstdynamik im öffentlichen Sector” (Cöttingen: Vandenhoeck & Reprecht, 1986).

  • Murlis, H., “Performance-Related Pay in the Public Sector,” Public Money (March 1987), pp. 2933.

  • Nunberg, B., “Public Sector Pay and Employment Policy Issues in Bank Lending: An Interim Review of Experience” (unpublished, Washington: World Bank, 1987).

    • Search Google Scholar
    • Export Citation
  • Office of Manpower Economics, Incremental Pay Systems (London, 1973).

  • Organization for Economic Cooperation and Development, “OECD Employment Outlook” (Paris: OECD, 1986).

  • Organization for Economic Cooperation and Development, “The Taxation of Fringe Benefits” (unpublished, Paris: OECD, 1987).

  • Ozgediz, S., “Managing the Public Service in Developing Countries,” Staff Working Papers, No. 583 (Washington: World Bank, 1983).

  • Public Salaries Review Commission, Uganda (1982).

  • Rabin, J., T. Vocino, W.B. Hildreth, CO. Miller, eds., Handbook on Public Personnel Administration and Labor Relations (New York; Basle, 1983).

    • Search Google Scholar
    • Export Citation
  • Siedentopf, H., ed., “Public Personnel Management in Asian Civil Services” (Mainz, 1983).

  • Sussmann, Z., and D. Zakai, “Changes in the Wage Structure of the Civil Service and Rising Inflation,” Bank of Israel (1985).

  • Tanzi, V. (1987a), “Fiscal Policy, Growth, and the Design of Stabilization Programs,” in External Debt, Savings, and Growth in Latin America, ed. by Ana Maria Martirena-Mantel (Washington; Buenos Aires, 1987), pp. 12141.

    • Search Google Scholar
    • Export Citation
  • Tanzi, V. (1987b), “The Public Sector in the Market Economies of Developing Asia,” Asian Development Review, Vol. 5 (No. 2, 1987), pp. 3157.

    • Search Google Scholar
    • Export Citation
  • Taylor, P.Minus a Bottom Line, Merit System Earns Demerits,” The Washington Post (January 18, 1983).

  • Twentieth Century Fund Task Force, The Government’s Managers: Report of the Twentieth Century Fund Task Force on the Senior Executive Service (New York, 1987).

    • Search Google Scholar
    • Export Citation
  • United Nations, Handbook of Civil Service Laws and Practices (New York, 1966).

  • United Nations, “Changes and Trends in Public Administration and Finance for Development,” second survey (New York, 1982).

  • United States Office of Personnel Management, “Significant Progress in Pay-Far-Performance, 1980–1982” (August 1983).

  • Zoeteweij, H., “Indirect Remuneration” (Geneva: OECD, 1987).


I am indebted to Vito Tanzi and Peter Heller for many valuable comments on an earlier draft of this paper. I am solely responsible for any remaining errors.


See Tanzi (1987a) for a discussion of how structural changes could be integrated in the design of stabilization programs.


See Heller (1985) for the role of government expenditure in Fund-supported adjustment programs.


The public service, however, while isolated from product market forces, is subject to external labor market pressures. The government must recruit and retain employees in competition with other employers.


A related structural expenditure issue is the balance between investment expenditures and expenditures on operation and maintenance (which include personnel expenditures). In many developing countries in recent years, there has been a tendency to give high priority to new public investment projects while not providing adequate resources for operation and maintenance of existing infrastructures. For this and other reasons, it has been suggested that the level of public investment expenditure in developing countries be reduced for a while. See Tanzi (1987b).


In some cases, the decline in the real level of remuneration has been aggravated by delays in the payment of wages and salaries. For a general discussion of issues related to government arrears, see Diamond and Schiller (forthcoming).


The figures refer to basic starting salaries. Thus, they do not take into account a number of other factors, which affect the compensation of government employees, such as fringe benefits, promotions, and individual advancements up the pay scale.


The Public Salaries Review Commission (1982) in Uganda found that “the civil servant had either to survive by lowering his standards of ethics, performance and dutifulness, or remain upright and perish. He chose to survive.”


For a concise survey of recent experiences, see Harris, Andoh, Evlo, and Starr (1987) and Nunberg (1987).


While there is a large body of literature on the design of private sector pay systems, not much has been written on pay systems for the public sector. Exceptions are Rabin, Vocino, Hildreth, and Miller (1983) and United Nations (1966).


article image


Areas in the U.S. civil service where grades are not based on the rank-in-job but on the rank-in-man approach include the military and (since 1978) about 7,000 upper management positions.


The experience of various Asian countries in restructuring their civil service system in the last two or three decades is reported in Siedentopf (1983).


The Organization for Economic Cooperation and Development (OECD) has published surveys for nonwage labor costs in developing countries. The concept of nonwage labor costs is broader than that of pay supplements; it also includes elements that do not constitute a remuneration of employees, such as tax payments and recruiting costs. Moreover, the OECD data do not refer to civil servants but only to private sector employees. It shows, among other things, that the dispersion of the share of nonwage costs in total labor costs was considerable in EC countries in the early 1980s, ranging from 15 percent (Denmark) to 45 percent (Italy). See OECD (1986).


See Zoeteweij (1987) for a general discussion of indirect remuneration in both the private and public sector.


In the United States, such exit barriers have been reduced in 1986 by creating a more portable pension plan for government employees.


The fact that preferences differ among employees has led some American firms to adopt a so-called cafeteria program. Under such programs, the firm sets the overall value of the total nonsalary compensation package for each employee and lets the employees choose from a “menu” of different supplements.


There are three methods of valuing benefits in kind provided by an employer to an employee: the cost to the employer, the value to the employee, and the market value; see Carow (1981).


It has been argued that bribery tends to be greater in connection with capital expenditures than with current expenditures, which, at least partly, explains the underfunding of expenditures for the operation and maintenance of infrastructures experienced in many developing countries. See Tanzi (1987b) and Heller and Aghevli (1985).


A country where the curtailment of fringe benefits has been the principal means of attack on wage costs in recent years is Nigeria. Since 1985, pay supplements have been substantially reduced. Among others, transport allowances for skilled staff were cut by up to 75 percent, cash leave grants were cut in half, and subsidized lunches were abolished.


See Office of Manpower Economics (1973) for a discussion of various aspects of incremental pay systems, that is, pay systems that are based on pay scales.


See Hofstede (1980) and Ozgediz (1983) for a discussion of the question whether Western management practices are universally applicable.


See the following section.


In addition, at lower levels, a special pay scheme designed to address problems of recruiting and retaining qualified staff in certain occupational and regional areas, which was introduced in 1962, has increasingly been used. Between 1977 and 1986, the number of positions eligible for a higher pay has risen from 8,000 to 37,000.


Originally, up to 50 percent of the staff were eligible for a performance bonus. Because of displeasure over the Large number of performance bonuses awarded, Congress reduced the Limit to 25 percent of the staff and later, in a follow-up action, the Office of Personnel Management reduced it further to 20 percent of the staff.


See Murlis (1987) for the progress made so far in introducing performance-related pay for top executives in Great Britain.


See Heller and Tait (1983) for a cross-country comparison of intergrade relativities.


Jordan, for example, has been experiencing a sizable outflow of senior government employees to the nearby oil producing states.


To be more precise, one has to use income group specific price indices in lieu of a general consumer price index; furthermore, if there is a progressive income tax, the after-tax pay structure will change.


The U.S. postal service, for example, makes a bi-annual flat amount adjustment of 1 cent an hour for every four tenths of a point rise in the consumer price index; see International Labour Office (1984).


The recent compression of the base pay system in the U.S. Government can be explained to some extent by the fact that since 1967 the pay scales in the upper end of the grade ladder have been linked to the pay of members of Congress, who, for political reasons, tend to be reluctant to vote for raises in their own salary.


See Nunberg (1987) for an account of World Bank experience with selective upward adjustments in public sector salaries in Bangladesh, Ghana, Jamaica, Peru, and Sri Lanka.


See Ebrill (1985) for an introduction to the concepts and issues in the implementation of nominal indexation of wages.