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2.76 The results presented in Annex 2.6 also highlight a need to control for non-wage expenditure growth while implementing the administrative reform and modernizing public service in the country. Although the administrative reforms and associated attrition calls for an increase in non-wage expenditures, Russia is unlikely to sustain the current share of non wage expenditures in total core government administration costs (37 percent). It seems that this share would have to go down to at least 35 percent, which would represent a significant increase in financing in real terms.

2.77 It is notable that the conclusions made above significantly limit the range of civil service reform scenarios that appear affordable. In fact, only five groups of reform scenarios that satisfy the constraints described above as the following:

(i) moderate pay reform implemented at a low pace with a fair administrative reform effort (scenarios 6, 18, and 30);

(ii) moderate pay reform implemented at a medium pace with a fair administrative reform effort (scenarios 8, 20, and 32);

(iii) moderate pay reform implemented at a medium pace with a significant administrative reform effort (adjusted scenarios 9, 21, and 33);

(iv) moderate pay reform implemented at a high pace with a fair administrative reform effort (scenarios 11, 23, and 35); and (v) moderate pay reform implemented at a high pace with a significant administrative reform effort (scenarios 12, 24, and 36).

2.78 In summary, a realistic reform strategy should provide for a moderate pay reform targets and be supported either by significant or fair administrative reform effort.

2.79 As shown in Table 2.12, the total fiscal costs of these reform scenarios in 2010 vary between 1.2 p.p. GDP and 2.3 p.p. GDP. Figure 2.2 illustrates the range of fiscal implications simulated for the selected groups of scenarios. To simplify further analysis and because the variation in pace of pay reform does not have a major impact on fiscal costs of reforms (as discussed in Annex 2.6), hereinafter we concentrate on analyzing the two groups of above mentioned scenarios, namely, (ii) and (iii) that represent a median of the reform options that we consider practical. To reflect the earlier finding with respect to a need for limiting the share of non-wage costs in the total core government administration costs, we undertook further adjustment of scenarios in the group (iii) (scenarios 9, 21, and 33) to reduce a share of non-wage expenditures to 35 percent.

Figure 2.2: Total Fiscal Costs of Selected Scenarios (p.p. of GDP as compared to 2003)Source: Staff estimates.

2.80 As shown in Figure 2.2, the fiscal implications of the selected reform scenarios highly depend on the share of real wages in GDP. In fact, if the real wage growth is 1 p.p. higher than GDP growth (as in the scenarios 20 and 21), the fiscal costs of the reform implementation are conveniently stable and account for about 1.61.7 p.p. of GDP in additional spending as compared to 2003. This stability is partly related to the substantial increase in cash compensation implemented in October 2003 for the entire civilian public sector40. The fiscal implications of this policy measure have already been incorporated into the 2004 budget, and hence in fact a significant portion (more than two thirds) of the overall reform-related additional costs has already been accommodated by the government. Overall, the analysis suggests that the reform strategy that provides for a moderate pay increase in core government administration combined with significant attrition (though differentiated by employment groups) and considerable increase in financing of non-wage costs could be implemented within (or almost within) the currently established fiscal constraints, i.e.

relatively little of additional financing may be needed compared to 2004 budget. However, some redistribution of funding between the various expenditure categories within the consolidated budget would be required.

2.81 Such an outcome of low reform costs is possible, however, only if a broad approach to civil service reform is followed. Figure 2.3 presents a breakdown of the total reform costs between two parts of the public sector employment. It shows that in fact even moderate pay increase in core government administration (complemented by some attrition) would bring about an increase in budget expenditures on this part of public employment. However, this increase may be compensated by a decline in overall costs of financing the civilian public See the text of this section for the description of the selected scenarios.

It is noteworthy that significant attrition may also cause additional expenses, since some of the benefits provided to civil servants do not cease after the termination of their employment. The situation may already change with the adoption of the new laws On Federal Civil Service and On Municipal Service. Assessing the impact of such additional costs would require substantial analysis related to age profile of the civil/municipal service and evaluating the opportunity costs for running parallel medical care structures, etc. Such analysis is beyond the scope of this Report.

sector, which becomes possible because of lower salary increases and higher attrition rates proposed for this sector as compared to core government administration.

Figure 2.3: Fiscal Implications of Scenario 2041: Core Government Administration and Civilian Public Sector (p.p. of GDP as compared to 2003) Source: Staff estimates.

2.82 This pattern, however, changes drastically if the civil service reforms are not complemented by any administrative effort to reduce overstaffing (especially in the civilian public sector). Should moderate pay reforms be implemented without any employment reductions, the fiscal costs of reforms would be almost twice higher and reach about 3.5 p.p.

of GDP by 2010 (in case of medium growth of the real wages). Figure 2.4 illustrates this drastic expenditure growth.

Figure 2.4: Fiscal Implications of Civil Service Reform: Role of Administrative Adjustments (p.p. of GDP as compared to 2003) 4.3.moderate pay adjustment with 3.administrative reform 2.(Scenario 20) 2.moderate pay 1.adjustment without administrative reform 1.(Scenario 19) 0.0.2004 2005 2006 2008 Source: Staff estimates.

2.83 The detailed structure of additional fiscal costs resulting from the reform implementation (for the year 2010) is illustrated in Table 2.13, for which we selected two scenarios with a medium growth rate of wages, namely 20 and adjusted 21. As demonstrated in Table 2.13, the broad structure of expenditure increase under the selected scenarios is very similar.

Scenario 20: Moderate pay reform implemented at a medium pace with a fair administrative reform effort and medium growth in private wages.

of GDP Total Fiscal Expenditures Increase, p.p.

Table 2.13: Structure of Expenditure Increase in Year 2010 for Selected Scenarios (in p.p. of GDP) Medium-Paced Moderate Pay Medium-Paced Moderate Reform with Fair Pay Reform with Significant Administrative Adjustment Administrative Adjustment (Scenario 20) (Scenario 21, adjusted)* A. Core Government Administration 1.13 1. o/w: costs to Federal Budget 0.58 0. Costs to Sub-Federal Budgets 0.55 0.a. Cash Compensation 0.77 0.Federal Budget 0.38 0.Sub-Federal Budgets 0.39 0.b. Non-Wage Expenditures 0.44 0.Federal Budget 0.20 0.Sub-Federal Budgets 0.23 0.c. Staff Attrition 0.00 0.Federal Budget 0.00 0.Sub-Federal Budgets 0.00 0.Increased Collection of PIT (sub- -0.08 -0.federal budgets) B. Civilian Public Sector 0.60 0.Employment o/w: costs to Federal Budget 0.23 0. Costs to Sub-Federal Budgets 0.37 0.a. Cash Compensation 0.63 0.Federal Budget 0.23 0.Sub-Federal Budgets 0.42 0.b. Staff Attrition 0.01 0.Federal Budget 0.00 0.Sub-Federal Budgets 0.01 0.c. Increased Collection of PIT -0.06 -0.(sub-federal budgets) Total Expenditure Increase (A+B) 1.71 1. o/w: costs to Federal Budget 0.82 0. Costs to Sub-Federal Budgets 0.91 0.* Assumption related to the share of non-wage expenditures in total costs of core government administration was adjusted to 35 percent as compared with the original share of 36 percent.

Source: Staff estimates.

2.84 As discussed above, significant portion of these fiscal costs has already been incorporated into the consolidated budgets. Based on our simulations, fiscal implications of civil service reform in core government administration account for almost two thirds of the total additional costs and require increased financing of about 1.1 p.p. of GDP, distributed almost equally between the federal budget and sub-federal budgets. Most of these additional costs would be required for financing the executive branch of the core government administration.

Table 2.14: Detailed Breakdown of the Increase in Fiscal Costs of Civil Service Reform in Core Government Administration as of (in constant 2002 billion rubles) Medium-Paced Moderate Medium-Paced Moderate Pay Pay Reform with Fair Reform with Significant Net Expenditure Increase Administrative Adjustment Administrative Adjustment (Scenario 20) (Scenario 21, adjusted)* A. Cash Compensation 156.59 139.A1. Federal Authorities 71.88 65. legislative authorities 3.09 3. executive authorities 43.64 37. o/w HQ-based 6.62 5. judiciary authorities 24.26 24.other authorities 0.88 0.A2. Regional and Municipal Authorities 84.71 73. legislative authorities 3.74 3. executive authorities 77.74 66. judiciary authorities 2.24 2.other authorities 0.99 0.B. Non-Wage Expenditures 57.92 70.B1. Federal Authorities 27.10 33. legislative authorities 1.37 1. executive authorities 15.82 18. judiciary authorities 9.52 12.other authorities 0.39 0.B2. Regional and Municipal Authorities 30.82 37. legislative authorities 1.47 1. executive authorities 28.09 33. judiciary authorities 0.87 1.other authorities 0.39 0.C. Increased PIT Collection (15.91) (14.17) Total Costs (A+B+C) 198.60 195. o/w: costs to Federal Budget 98.98 98. costs to Sub-Federal Budgets 99.62 96.Total Costs (as a % of GDP) 1.13 1.Note: Figures may not sum up due to rounding.

* Assumption related to the share of non-wage expenditures in total costs of core government administration was adjusted to 35 percent as compared with the original share of 36 percent.

Source: Staff estimates.

2.85 Table 2.14 presents additional breakdown of the expected expenditure increase under the scenarios 20 and 21 (adjusted) if the reforms are limited only to core government administration. It shows that most of the expected fiscal gains from more significant administrative actions in scenario 21 are likely to be spent on additional non-wage expenditures.

2.86 The recent debates on the pay reform in Russia suggest that the pay adjustments should have a stronger focus on the middle and top management of the civil service (decision-makers) employed in headquarters of the federal executive authorities. This would allow retaining the most qualified managers within the executive bodies and would result in better government performance, including improved policy making (for more deliberations on this scenario see HSE, 2004, report).

2.87 To take into account this policy option, we introduced additional modifications to the selected moderate pay reform scenarios, namely: scenario 20, assuming fair administrative changes; and scenario 21, assuming significant administrative reform. These modifications decreased the residual public-private pay gap for HQ-based federal executive civil servants of Categories A, B, and part of the Category C (Top and Chief Groups) from 100 percent (default value for all scenarios with moderate pay adjustment, such as e.g. scenarios 20 and 21) to 50 percent. As of 2002, the share of these civil servants in the total number of civil servants employed in HQ of federal executive bodies accounted for about 14.1 percent. It is expected that administrative reform efforts would not significantly affect this share (in 2010, the share of officials in these Categories would account for 14.2 percent of HQ-based executive civil service in case of fair administrative reform and for about 13.9 percent in case of significant attrition, respectively).

Table 2.15: Fiscal Implications of More Radical Pay Adjustments for Decision Makers in Federal Executive Civil Service Headquarters as of Cash Compensation for Federal Executive HQ-Based Officials Medium-Paced Moderate Pay Medium-Paced Moderate Pay Reform with Significant Reform with Fair Administrative Administrative Adjustment Adjustment (Scenario 20) (Scenario 21 adjusted) Constant 2002 % of 2010 Constant 2002 % of billion rubles GDP billion rubles GDP Costs of the base case, with 10.66 0.080 9.76 0.No additional measures Costs of additional pay 11.30 0.085 10.34 0.adjustment for decision makers Source: Staff estimates.

2.88 Table 2.15 shows that the extra pay increase for the decision making group of HQbased federal executive authorities would not bring about significant additional fiscal pressures: the costs of such an extra step would account for about 0.6 billion rubles in prices (less than 0.005 percent of 2010 GDP). Such a policy measure would result in both better external competitiveness of the civil service in the labor market and in greater internal decompression: by the end of the reform, the compression ratio for HQ-based federal executive civil service would increase to 9.0, which is 0.8 higher than in the base case with moderate pay reform.

2.89 Another suggestion often made in the debates on implementation of civil service and administrative reforms relates to a possible separation of administrative reform from the pay reform in core government employment and from the corresponding adjustment in the civilian public sector at large. To simulate potential effects of this reform strategy, we made further modifications to the above scenarios 20 and 21 based on the following additional assumptions:

Administrative reform measures in core government administration and civilian public sector would be implemented within 20042006, i.e., under the compressed schedule;

Pay adjustment in core government administration would be implemented in 2004 2008; and Pay adjustment in the civilian public sector would be implemented in 20042010, i.e., at a slower pace.

Figure 2.5: Total Fiscal Implications for Scenarios42 with the De-Linked Implementation of Pay and Administrative Reform Components (p.p. of GDP) Source: Staff estimates.

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