Pay and Benefits in the

Public Sector
Martin Rama
Development Research Group

Public Expenditure Analysis
& Management Staff Training Course
Washington, DC, May 22-24, 2001
The Problem
The wage bill is usually the largest item in public
sector spending
Salaries and benefits result from historic legacies,
fiscal adjustments, political pressures, etc.
Pay tends to be compressed compared to the
private sector (low top-to-bottom ratios)
Low pay could lead to the departure of qualified
staff and encourage corruption
The Solution
Pay and benefits should be similar in the public
and the private sectors
An immediate alignment may not be feasible, but
the direction should be clear
The alignment may lead to gains for some public
sector workers, and losses for others
Methodological Issues
The private sector is very heterogeneous in
developing countries (formal versus informal
activities)
Benefits account for a different share of total
compensation in the public sector and in the
private sector(s)
Some important benefits (job security, low
effort) are difficult to quantify
In Practice, Two Strategies
The jobs approach: estimate the total
compensation associated with similar jobs in the
private sector (e.g. secretary, driver)

The workers approach: estimate the total
compensation a public sector worker would get if
he/she had to move to the private sector
The Jobs Approach
Widely used in industrial countries, and even by the
World Bank (Hay points)
Relies on the identification of appropriate private
sector comparators
Problem: the chosen comparators are often the best
companies in the formal sector
Experience from downsizing shows that many public
sector workers end up in the informal sector.
Example: the 2000 arbitration award in Guyana,
doubling government pay.
An illustration: State-owned
Enterprises in Vietnam
Annual net salary in main occupation
Private sector workers
Job description
SOE
workers At entry level At mid- career
Cleaners 8094 37764 44028
Office workers 8068
53436 62364
Accountants 10743
75708 88308
Based on work in progress by Bales and Rama. All figures are in thousand vnd.
Data on private sector earnings are from a salary survey commissioned by UNDP.
The Workers Approach
Relies on the estimation of the pay and benefits a
specific worker would get if he/she moved out of
the public sector
This is the same as estimating the amount of
compensation he/she would need in the event of
job separation
Implication: a public sector worker cannot be both
underpaid and reluctant to leave in exchange for
generous compensation
Implementation of this Approach
Rely on household survey data (e.g. LSMS) to
estimate private sector earnings as a function of
worker characteristics (age, education, etc.)
Predict alternative earnings of public sector
workers by plugging their individual characteristics
into the estimated earnings function
Use the distribution of estimated earnings gaps to
infer the value of intangible public sector benefits
(more on this below)
Main Potential Weakness
Public sector workers may be different from private
sector workers in unobservable ways (e.g. they could
be better connected, or less entrepreneurial)
Failure to control for unobservable characteristics
will bias the estimates (e.g. we will compare with the
private sector earnings of someone who is not well
connected, or is more entrepreneurial)
How serious is this potential bias?
An Illustration: State-owned
Enterprises in Vietnam
If the bias from unobservable characteristics matters,
then it has to matter in Vietnams SOEs
Under central planning, SOE jobs were deliberately
allocated based on political loyalty and to compensate
for sacrifices during independence wars
In the early 1990s, a voluntary downsizing program
led to the departure of the most entrepreneurial third of
the SOE workforce.
Six Ways to Estimate the Gap
OLS: Estimates earnings functions based on observable
characteristics only
HECKMAN: Standard approach to correct for self-selection on
unobservable characteristics
SWITCHING: More elaborate version of the above
FE-TIME: Focuses on workers who shift from public to private
sector or vice-versa
FE-HHOLD: Focuses on individuals who belong to the same
household but work in public versus private sector.
MATCHING: Compares with most similar private sector
worker(s), rather than with a regression line.
Some Results
OLS HECKMAN SWITCHING FE-TIME FE-HHOLD MATCHING
OLS 1.000 0.9968 0.9797 0.4208 0.5726 0.5690
HECKMAN 1.0000 0.9738 0.4317 0.5787 0.5753
SWITCHING 1.0000 0.3959 0.5837 0.5669
FE-TIME 1.0000 0.2941 0.2497
FE-HHOLD 1.0000 0.3463
MATCHING 1.0000
Mean 0.338 0.331 0.266 0.245 0.237 0.343
Median 0.312 0.295 0.258 0.254 0.240 0.296
Source: Based on work in progress by Bales and Rama. Data on earnings and individual
characteristics are from the 1992-93 and 1997-98 rounds of the VLSS.
A Crude Comparison
The jobs approach suggests that SOE workers earn 4
to 8 times less than private sector workers
The workers approach shows that they actually earn
about 30 percent more
The mean and median gap are stable, regardless of
the econometric technique used
Even individual gaps are quite stable, as revealed by
the significant correlation coefficients
Assessing Benefits
Both the jobs approach and the workers approach
assume that benefits are the same in the public and
the private sectors
The comparators chosen in the jobs approach may
offer similar benefits, but they require higher
effort and provide less job security
Benefits such as health coverage and old-age
pension are usually unavailable in the informal
sector
Methods to Assess Benefits
Direct method: Calculate the value of the most
significant benefits available in the public sector but
not in the informal sector (e.g. old-age pension)

Indirect method: If a worker who could earn X%
more in the private sector does not leave voluntarily,
he/she must value the intangible benefits at X% of
his/her salary at least.
An Illustration: Civil Servants in
Guinea-Bissau
Note: Based on Chong and Rama (2001). The solid line is constructed
under the assumption that all separated workers get jobs in the
private formal sector of the economy, whereas the dotted line
assumes that they all end up working in the informal sector.
0
10
20
30
40
50
60
70
80
90
100
-70 -60 -50 -40 -30 -20 -10 0 10 20 30 40 50 60 70
Change in earnings (%)
A
c
c
u
m
u
l
a
t
e
d

e
m
p
l
o
y
e
e
s

(
%
)
Main Findings in Guinea-Bissau
All civil servants in N-Z categories would lose if
they moved to the informal sector, but a quarter of
them would earn more in the private formal sector
Based on the estimated gains, and the probability
of finding a job in the private formal sector, the
value of intangible benefits is around 20 percent of
the measurable earnings
The direct method, based on the present value of
old-age pension, yields similar results
Conclusions
Having clear benchmarks is important to reform public
sector pay over time, minimizing risks of either over-
spending or losing qualified personnel
The jobs approach yields an excessively high
benchmark, because it focuses on the best companies,
and not on the true alternatives of public sector workers
The workers approach can be implemented in any
country with decent household survey data, of the kind
we use in our poverty work
Conclusions (Contd.)
The main weakness of the workers approach is the
potential bias created by unobservable worker
characteristics
However, this bias does not appear to be substantial,
and even simple econometric techniques (such as
OLS) could yield decent results
The workers approach can also be used to estimate the
value of intangible benefits offered by the public
sector, which are part of total compensation
References
Cited in the presentation:
Bales, Sarah and Martin Rama (2001): Are Public Sector Workers Underpaid? Appropriate Comparators in a Developing
Country, work in progress, Washington, DC: The World Bank.
Chong, Alberto and Martn Rama (2001): Do Compensation Packages Need to Be that Generous? Simulations for
Government Employees in Guinea-Bissau, in Shantayanan Devarajan, F. Halsey Rogers and Lyn Squire (eds.):
World Bank Economists Forum, 1, p. 169-194, Washington, DC: The World Bank.
Other references:
Adamchik, Vera A. and Arjun S. Bedi (2000): Wage Differentials between the Public and the Private Sector: Evidence
from an Economy in Transition, Labour Economics, 7(2), p. 203-224, March.
Filmer, Deon and David Lindauer (2001): Does Indonesia Have a Low Pay Civil Service? unpublished manuscript,
Washington, DC: The World Bank.
Hou, Jack W. (1993): Public-Private Wage Comparison: A Case Study of Taiwan, Journal of Asian Economics, 4(2), p.
347-362, Fall.
Lindauer, David and Richard H. Sabot (1983): The Public-Private Wage Differential in a Poor Urban Economy, Journal
of Development Economics, 12(1-2), p. 137-152, February-April.
Mengistae, Taye (1998): Wage Rates and Job Queues: Does the Public Sector Overpay in Ethiopia?, Working Paper
Series, WPS/98-20, Oxford, UK: Centre for the Study of African Economies, December.
Psacharopoulos, George, Jorge Valenzuela and Mary Arends (1996): Teacher Salaries in Latin America: a Review,
Economics of Education Review, 15(4), p. 401-406.
Stelcner, Morton, Jacques van de Gaag and Wim Vijverberg (1989): A Switching Regression Model of Public-Private
Sector Wage Differentials in Peru: 1985-86, Journal of Human Resources, 24(3), p. 545-559, Summer.
Terrell, Katherine (1993): Public-Private Wage Differentials in Haiti: Do Public Servants Earn a Rent?, Journal of
Development Economics, 42(2), p. 293-314, December.