Tuesday, November 24, 2015

Economy can shrug off Seventh Pay Commission impact

All the doomsaying we heard before the report of the Seventh Pay Commission(SPC) has turned out to be nonsense. The hike in pay is a modest 16%, with a total increase of 23.55 per cent after taking into account allowances and pension. Let me spell out the impact:
  • Fiscal deficit: The impact on the central government is 0.46% of GDP which reduces to around 0.4% of GDP once taxes are taken into account. A correct way to look at the impact is to amortize this impact over a business cycle. If amortized over, say, five years, the annual impact is a piffling 0.08%
  • Output and growth: Government spending on pay will rise. Analysts think this will be expansionary as it was during the time of Sixth Pay Commission. They are wrong. On the last occasion, higher pay was allowed to translate into a higher fiscal deficit. This time, the finance ministry has said the targeted reduction in fiscal deficit from 3.9% of GDP in 2015-16 to 3.6% of GDP in 2016-17 will be adhered to. This means that increased pay will be offset by reductions on other accounts. The pay hike will, therefore, not be expansionary
  • Inflation: For the same reason as above, the pay hike will not have a significant inflationary impact
  • Sectors: Higher spending by government employees can provide a modest stimulus to sectors such as real estate, consumer goods and automobiles. The stimulus will be modest because the increases in pay are not very large.
 The SPC has improved terms for pensioners considerably but the outcome falls short of one rank, one pension. Earlier, retireees used to be placed at the minimum of the new pay bands corresponding to the levels at which they retired. Now, they will be given increments corresponding to the increments they got above the minimum. This is a huge benefit to pensioners.But it's not one rank, one pension. All retired professors don't get the same pay- there will be a difference depending on the number of years for which they served as professor.

Critics of Pay Commissions have said that the tail is government is too long and the head too small. This can change if the government wishes. There will be large retirements in the C and D categories. These can be left unfilled and the government can instead hire in larger numbers at the officer level. In the years ahead, there is a great opportunity to right size the government and bring in diverse skills.

Overall numbers have been growing mainly in the ministry of home affairs (police and paramilitary forces), not so much in most other ministries and departments. The SPC provides data that shows that India's bureaucracy in relation to the population is much smaller than that of the US.

The other criticism of Pay Commissions is that they have not emphasised performance and productivity adequately. The Sixth Pay Commission had proposed a performance-related incentive scheme (PRIS). The SPC notes that it hasn't quite taken off because of numerous operational difficulties. It also notes correctly that performance measurement in government is rather difficult. It is less difficult in the private sector where performance can be measured against defined commercial targets (although even this is done badly in most private firms). The SPC proposes performance related pay linked to a new framework.

My sense is that operationalising this framework will prove just as difficult as the Sixth Pay Commission PRIS. The focus in government should be primarily on collective performance as measured by independent audits, the reports of which are made transparent. There should be penalties for collective under- performance (such as delayed promotions and even compulsory retirement). Financial rewards for good performance should be for a team as a whole and the amounts should be quite modest. Anything else will create havoc in government.

There is a strong case for creating a separate management audit department in the CAG. All government departments, agencies, regulators and autonomous institutions must come under its purview. The management audit should focus not just on outcomes but also on internal processes and governance and should cover HR issues. Where processes and governance are weak, it will be reflected in outcomes. A management audit should capture these before outcomes are undermined.

More on the SPC report in my article in the Hindu, Why we  must not grudge them a pay hike


Anonymous said...

Thanks Prof!... Your comments on rightsizing are quite true.. i have worked with public hospitals and have seen that public investment and in general personnel are woefully inadequate. Similarly I have heard that the number of vacancies that are shortfall of engineers in electrivity boards in urban and peri urban areas of Mumbai/Thane are high ... maybe a product of poor working conditions and low benefits. I have no idea of situation in other states. Donot know if any unofficial freeze is on.

I think we have a high number of Class III and Class IV employees in many government offices. Usually because of government announcements etc. for various schemes.

Thankfully you have given a fresh perspective rather than the fiscal fundamentalist views provided by the usual suspects.

- Deepak

iitmsriram said...

Nice article. However, I believe your take on pensions and "OROP" is not correct. You state "Earlier, retireees used to be placed at the minimum of the new pay bands corresponding to the levels at which they retired." This is not correct. Pensioners also get pay fitment (fixation) as given to serving employees - in some cases it may be the minimum of the revised scale, but if they have a good number of increments in the scale at the time of retirement, the fitment will not be at the minimum. However, as pensioners do not get annual increments and also do not get the benefits of increments at the time of pay commission revision, they eventually (after one or two pay commissions) end up at the minimum of the pay band / scale corresponding to the cadre of retirement. For example, a professor retiring after drawing 12 increments in the professor scale would start drawing pension corresponding to this pay, but after one pay commission, would be drawing only the equivalent of 1 or maybe 2 increments and in the next pay commission would end up at the minimum of the scale. With OROP as agreed to by the government, the effect of increment bunching is offered to pensioners also, so this 12 pre-retirement increments will become (with increment bunching factor of 3, say, as used by the 5th pay commission) 5 increments after one pay commission and 2 increments after two pay commission and go to minimum of scale only after the 3rd pay commission after retirement. OROP gives additional delay in the pensioner decaying to the level of minimum of scale. The 6th pay commission used a bunching factor of 2, this would delay the decay further. The 6th pay commission provision of additional old age pension (20% after age 80, 30% after 90) would further help counter the erosion of pension.

Ravi said...

Great article, with full of analysis, worth reading. thanks for sharing.

G. Syam Nath said...

Dear Professor,

I agree with most of your analysis except one point. You have stated that the 0.4% impact on government expenditure due to the SPC is a one-time effect and hence has to be amortized over a business cycle. I beg to differ. I believe that this argument for amortization is true only for the arrears paid. The increase due to revision other than arrears is not a one-time effect. It continues year after year. It also increases due to increments, promotions, DA, etc. Hope you will agree.

T T Ram Mohan said...

Syam Nath,

There is an increase at one point in time, that is, the base goes up. There are no increases on top of that thereafter. Hence a one-time effect.