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The most recent discussions related to possible scenarios of the pay reform are presented in the HSE (2004) report.

well as in the public sector at large (in the general government), even if the current legislation provides no formal links between the wages levels of civil servants and those of other civilian public sector employees. Otherwise, it would be quite difficult politically for the Government to sustain a drastic increase in the salary gap between the civil servants and the rest of the public sector employees. The importance of this link was highlighted once again by the recent government decision regarding salary increases in the public sector, including a percent pay increase in the entire public sector in October 2003 and the proposed similar allinclusive 50 percent increase for 2004. Hence, the approach followed in this Chapter is that the fiscal implications of the proposed reforms in civil service should be simultaneously assessed in two different frameworks:

narrow approach covering fiscal costs of reforms in core government administration; and broad approach assessing fiscal implications of a comprehensive reform package and salary adjustment in the entire civilian public sector employment.

2.25 It is recognized that in fact the proposed broad approach may be expanded even further to include the fiscal costs associated with the increased pay in police service and armed forces. These spheres were not included in this Chapter because of the lack of data readily available for simulations. Moreover, inclusion of the armed forces into the analysis would call for additional analysis of military reform options, which is a large task in itself26.

Also, it is recognized that implementation of civil service reform would create additional pressures on the pension system, since keeping a decent proportion between the pensions and wages is another important policy constraint. Proper consideration of this area would require separate research and would have to be analyzed in the context of the pension reform. Fiscal implications of the pension reform are presented in a companion Chapter prepared jointly by the Bank and the Institute for Economy in Transition.

2.26 It should be noted that the implementation of civil service reforms would bring about not only fiscal costs but also result in noticeable fiscal and economic benefits associated with a stronger productivity growth, better resource allocation (achieved through granting more autonomy to government agencies in reallocation of budgeted funds, adoption of more transparent procurement practices and wider application of competitive procurement methods, etc.), automation of business processes, increased efficiency in the use of public property, and better quality of public services. However, it is difficult to estimate most of these benefits in quantitative terms and it will take time for most of these benefits to materialize. Hence, they have not been taken into account for the purposes of this analysis.

2.27 The earlier attempts to estimate fiscal implications of the on-going civil service reform in Russia have been limited and were focused on particular components of the overall reform costs. In 200304, the Higher School of Economics published some estimates related to fiscal effects of targeted pay increase for federal headquarter-based civil servants, as well as investment costs associated with the introduction of new technologies in the federal civil Rationale for inclusion of non-civil servants into the analysis of fiscal implications of the pay reform may be illustrated by the example of the State Customs Committee that currently has three types of personnel: (i) civil servants; (ii) uniformed personnel (that includes staff performing intelligence functions, as well as all staff at the positions of Division Chief and above); and (iii) staff with employment regulated by the Labor Code. In this case, should it be decided to adjust the pay scale for civil servants, it clearly has to be adjusted at least for the category (ii), but also probably for the category (iii).

service. The later were further refined in the framework of drafting a Federal Program Administrative Reform (200510). The Presidential Program Reforming the Civil Service (200305) also presented some estimates for investment costs related to drafting new civil service legislation and developing new methodologies and instructions needed to carry out both pay and HR management reforms. However, there have been neither attempts to estimate the full fiscal costs of all the above components, nor any assessments of a systemic fiscal effect of the on-going reform on the entire costs of financing the civilian public sector.

D. DATA SOURCES AND KEY ASSUMPTIONS 2.28 Data Sources. The data used for calculating the fiscal implications of civil service reform includes October 2002 public sector statistics published by Roskomstat in 2002; data on pay and employment in core government administration for 2001 and 2002 (Roskomstat 2002 and 2003); results of pay and public officials surveys conducted in 20022003 and sponsored by DFID (HSE, 2003, forthcoming); international statistics on the education and health sectors (including WHO and Bank data); international pay and employment database maintained by the Bank (World Bank database); as well as data obtained from other sources (a complete list of sources is presented at the end of the Chapter).

2.29 Because of the lack of up-to-date comprehensive pay and employment data in Russia, the following assumptions were applied to calculations of the pay and employment baseline:

For Core Government Administration Because of the lack of data on employment breakdown by groups/categories for 2002, we assumed that the 2001 employment structure remained unchanged and applied the 2001 shares to the 2002 employment levels.

Because of the lack of data on compensation by groups/civil service categories for 2002, we applied the actual average compensation increases in relevant branches and levels of the government to all 2001 categories/groups proportionally assuming that the compression ratio remained unchanged.

For Civilian Public Sector Employment We assumed that the compensation level as of October 2002 is equal to the average compensation level in 2002.

Roskomstat (2002) data contained average compensation levels with breakdown per four major civilian public sector branches (see Figure A2.1 in Annex 2.1) and per level of government (i.e., federal, regional and municipal). These compensation levels were applied to all sub-sectors within each branch.

It was assumed that organizations classified as being federal property are financed from the federal budget, while the entities in regional and municipal property are financed from sub-federal budgets.

Roskomstat (2002) data cover all organizations in the civilian public sector that are partly or fully financed from the budget. For the purposes of this Chapter it is assumed that the reported wage bill and social charges of civilian public sector employees were fully financed from the respective budgets.

2.30 Key Macroeconomic Assumptions. Macroeconomic assumptions for our simulations were developed jointly with the experts from the Institute of Economy in Transition. The basic principles of the macroeconomic framework used in our work for costing out various structural reforms are presented in Annex 3.1. In sum, we took the Governments baseline macroeconomic projections for the period 2004-2006 and used them as a basis to build a set of four macroeconomic scenarios, each of which reflects a specific combination of two primary determinants of Russias future macroeconomic performanceaverage oil price and expected speed of structural reforms. Our initial plan was to use the four macroeconomic scenarios as a basis on which we would design and elaborate further more detailed subscenarios of specific structural reforms27.

2.31 However, in the case of reforms in public administration we came to the conclusion that it would be appropriate to modify our original plan and follow a simplified set of macroeconomic assumptions. The reason for such simplification derived from our early observation that the simulation results (presented in GDP p.p.28) are not sensitive to GDP growth rate. The simulations are also not sensitive to inflation, since the model assumes full annual indexation of wages in both core government employment and the civilian public sector. Therefore, we decided that it would be appropriate to develop cost estimates within the single macroeconomic scenario.

2.32 What significant for the outcomes of our costing exercise is the differences in growth rates, primarily the difference between the expected growth rate in private sector wages and GDP growth rates. The higher future wage growth in the private sector, the more expensive is the governments task of closing the existing pay gap. Overall, we concluded that the key macroeconomic parameter in the model is the ratio between real wage growth rate and real GDP growth rate. Currently, the share of payroll (including hidden wages) in the Russian GDP is quite low, but in the medium term we expect that in response to structural reforms it will be growing quite rapidly to approach the levels prevailing in other economies in transition. This would occur owing to increased competition, reduced share of the informal sector, and therefore improved wage/profit ratio in the economy. However, the costs of the proposed reform in civil service depend fundamentally upon the speed of this future catch up.

2.33 Based on the above considerations, we decided to base our simulations on the single macroeconomic scenario, but to consider three sub-scenarios that have different growth rates for the payroll share in GDP (Table 2.5). From our original four macroeconomic scenarios we selected the most optimistic one as our single macroeconomic framework. This scenario is described as a scenario with the advanced reforms and high oil prices in Annex 3.1.

Some analysis of possible military reform options is presented in the IET (2002) report.

This initial plan with multiple macroeconomic scenarios was fully implemented, however, for analysis of fiscal implications for two other structural reforms in the pension system and in housing/utilities. The results for these two reforms are reflected in separated papers.

Table 2.5: Key Macroeconomic Assumptions (in constant 2002 rubles) 2003 2004 2005 2006 2007 2008 2009 GDP growth, % 7.3 5.5 5.0 4.5 4.0 3.5 3.0 2.GDP, trln. RUR 10.0 10.5 11.1 11.6 12.0 12.4 12.8 13.GDP per capita, '000 RUR 69.9 74.1 78.2 82.0 85.7 89.1 92.2 94.Inflation, annual, % 10.0 10.0 10.0 10.0 10.0 10.0 10.Real investment growth, % 9 7.5 6.5 5.5 4.5 4 Real household incomes growth, % 7.5 7 6.5 6 5.5 5 4.Population (million people) 142.8 142.1 141.5 140.9 140.3 139.7 139.0 138.Scenario 1 (real wage growth rate exceeds GDP growth rate by 2 p.p.) Real Wage Growth, % 8.1 7.5 7.0 6.5 6.0 5.5 5.0 4.Scenario 2 (real wage growth rate exceeds GDP growth rate by 1 p.p.) Real Wage Growth, % 8.1 6.5 6.0 5.5 5.0 4.5 4.0 3.Scenario 3 (real wage growth rate is equal to GDP growth rate) Real Wage Growth, % 8.1 5.5 5.0 4.5 4.0 3.5 3.0 2.Source: Roskomstat, MoEDT, and staff calculations.

2.34 We selected the most optimistic scenario in order to highlight both the costs and risks of implementing the proposed reform package. At the same time it is quite clear that in the scenarios with low oil prices and respectively with much higher fiscal pressures, the same reform task would become much more challenging politically. In the case of a tight budget it would be much more difficult for the government to justify the need for a radical pay increase in public administration and convince society that a considerable budget restructuring that favors government employees is indeed urgently needed. In the discussion below we do not consider these additional and non-quantifiable policy risks could be derived from the overall deterioration in the macroeconomic situation, and which most likely would initiate additional pressures towards slower rates of reforms.

2.35 The selected macroeconomic framework is based on the assumption of an average growth rate of 5 percent for 20040629 and 4 percent for 20042010. It is worth noting that these growth rates are lower than those assumed in the corresponding government projections.

Overall, we expect that growth rates will decline after 2006. Better utilization of existing reserves in the economy, which was a critical growth factor in 19992003, cannot support the future growth in the same way as before because the reserves are to a large extent exhausted.

At the same time, we admit that this may be considered as a conservatively-optimistic scenario.

2.36 Private Sector Benchmarks for Net Cash Compensation Increase. The primary objective of the pay reform is to narrow the existing compensation gap between the core government administration and the private sector. However, so far the overall scope of the civil service pay reform remains undecided. Although some proposals on increasing the compensation only to a limited number of senior civil servants (or those holding strategically important positions) have been formulated (HSE, 2003 and 2004) and have recently been Costs reflected in absolute values, e.g., in constant 2002 rubles, would be different.

implemented through a Presidential Decree, drastically increasing the cash compensation for some HQ-based federal civil servants30, the sustainability of such an approach remains unclear and no further policy decisions related to deconcentrated units of federal bodies, as well as to core government administration in general, let alone the civilian public sector, have been taken so far.

2.37 For the purpose of this Chapter, the data from a comparative pay and benefits survey of the public and private sector (HSE, 2003) were utilized as a basis for the estimates for HQbased federal authorities employees, and then was adjusted to account for the regional wage differential, which was estimated based on the actual 2001 information about the pay differences between Moscow and other regions (Denisova, 2001). The specific figures applied are presented in Table 2.6.

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