Knowing the budget baseline is an essential part of good budgeting, which makes the methodology for estimating the baseline important. What follows focuses on the need, in many countries, to include within the baseline estimation methodology a wage bill model that is capable of quantifying the budgetary impact of public employment policies.
The budget baseline is the level of government expenditure assuming the continuation of current policy. Only by knowing the expenditure baseline over the medium-term can a government know how much fiscal space is available for new spending, consistent with its targets for the deficit and debt.
Wages and salaries for government employees are a very large part of most governments’ expenditure. How they are treated in the baseline is therefore important. Nowhere is this truer, however, than in the large number of countries where government employees enjoy a high level of job security. We are talking here about countries where civil servants cannot be fired at will, and making them redundant – to the extent that is possible – is a costly process which typically takes considerable time. If the government wishes to reduce public employment, it most often uses “natural attrition,” which means not replacing civil servants who retire or resign.
In such countries, the inflexibility of expenditure on wages and salaries makes the explicit recognition of the impact of employment policies on the wage bill an essential part of estimating the budget baseline. It is insufficient to use a model which assumes constant employment levels and adjusts only for salary adjustments (e.g. salaries rising by an average of 2 percent) and other “price” changes. Rather, it is necessary to have a model capable of quantifying the impact on the budget baseline of any policies that the government has — or may consider adopting— with regard to public employment levels.
To illustrate why this is the case, consider a situation in which the government decides that it wishes to reduce public employment and, to this end, announces a policy that in future only one of every two departing civil servants will be replaced. (This is a policy that the French government adopted some years back under President Sarkozy.) Under such circumstances, it would be essential to factor in this policy when calculating the wage and salary component of the baseline estimate for the coming years. Only by doing this would the impact of the new policy in reducing the budget baseline be made explicit. To continue under these circumstances to estimate the baseline on the assumption of constant levels of public employment would be a mistake, and would yield baseline estimates which are too high.
Similarly, if a government decides to go down the path of redundancies, using whatever provisions might exist for this in existing civil service legislation, this must be taken into account in the baseline estimate*.
The key takeaway here is that, in the many countries with a high degree of civil service job security, it is critical that the estimation of the budget baseline explicitly takes into account government policies on public employment levels. This requires an articulated model of wage and salary expenditure – a “wage bill model” — which includes employment policies as variables upon which the estimates are based.
Some might suggest that this is unnecessary because, under normal circumstances, government policy can be assumed to be the maintenance of existing civil service employment levels. But even under these circumstances, a model capable of estimating the budgetary impact of various options for changes to its employment policies is of great value during the budget preparation process, particularly if the fiscal position is tight and it is important to have all savings options on the table.
I make this point in the light of the technical note on budget baseline methodology recently published by the IMF. The note is an excellent — and much-needed — contribution to the technical literature on this important subject. However, its brief treatment of the wage component of the baseline focuses entirely on modeling the wage bill on the assumption of constant employment levels. Given that wage inflexibility and oversized wage bills are particularly widespread in the developing countries at whom the note is primarily targeted, there is in my view a need for wage bill models which go further than that. It would, however, be unfair to expect all of the aspects of this important topic to be covered in a single note. The topic requires the more detailed treatment that only a longer monograph could provide. But full marks to the IMF for this contribution.
*Redundancy costs may, however, require different treatment, because they are one-offs.