Subir Gokarn: The SPC opportunity

The Sixth Pay Commission needs to be given a much wider mandate than its predecessors had been.

Most commentators have expressed concern about the government's decision to set up the Sixth Pay Commission (SPC). Just as the fiscal situation appeared to be coming under control and the commitments under the Fiscal Responsibility and Budget Management (FRBM) Act showed a realistic chance of being achieved, higher compensation for government employees may well derail the process. The impact of the Fifth Pay Commission (FPC) is still fresh in people's minds. The government accepted the recommendations on salary increases but not the ones on downsizing, which would have offset some of the fiscal impact. It has taken a long time for central and state government finances to recover from that blow.

An assumption underlying this rather pessimistic view is that a fresh round of pay increases in the public sector will not be accompanied by any changes in its structure. In other words, more money will be paid out for the same, or even deteriorating, level of services being provided. This may well be an entirely justifiable assumption, but it begs the question. Virtually nobody would deny that the quality of public services, in the broadest possible sense, is way below desirable levels and improving it as quickly as possible is imperative from both economic growth and welfare perspectives. One component of this is surely to attract better talent and skills into the sector. Given the wide disparity that now exists between the high-skill positions in the private and public sectors, this objective is unlikely to be achieved without a significant upward revision in the latter.

However, the case for a large increase in public sector compensation cannot be made on the basis of this disparity alone. It has to be placed in a much wider context; one that explicitly links pay scales to both the quality of service delivery and the penalties for not meeting the standards committed to. Taken to its logical conclusion, this would involve a fundamental re-evaluation of what services the public sector should provide, how it should provide them and what internal incentive mechanisms are needed for efficient, high-quality delivery.

This may well appear to be too wide a mandate for a Pay Commission, which has traditionally had to work on the assumption that the existing structure was immutable. Other bodies have dealt with issues of structural change in the public sector. The boundaries within which the Pay Commission is expected to operate were brought home sharply by the government's complete dismissal of the FPC's suggestion that staff strength be reduced by 30 per cent.

Unfortunately, recent initiatives on structural change which the government appears to be considering, at least those which have received some media coverage, are somewhat tentative. Proposals such as "up or out", as prevails in the defence services, or more elaborate performance appraisals may strengthen incentives as far as individuals are concerned, but provide no guarantee that the system as a whole will respond. This gets me back to the initial point that the effectiveness of the system will be determined by the degree of alignment between its objectives, organisation and the incentives (and disincentives) it provides. Any solution that addresses one of these components without recognising the inter-dependence between them is unlikely to accomplish very much.

Therefore, assuming that the core objective of the government is to improve the quality of public services, rather than to just pay government employees more, the SPC needs to be given a much wider mandate than its predecessors had been. More time is not the issue; in any case, the minimum time that the process will take is two years. With the right composition of the commission, the two-year timeframe is adequate to accomplish the broader goal of re-aligning objectives, processes and incentives towards the ultimate objective of better service delivery. Only then will its recommendations be a positive and enduring legacy, rather than the fiscally destructive burden that so many people are justifiably worried about.

This opens up a large canvas, which will undoubtedly be filled with a number of columns over the next couple of years. Here are some initial thoughts on implementation.

One great barrier to change is the fear that the system could collapse completely in the process, leading from service provision, however inadequate and inefficient, to no provision at all. The risk is clearly unacceptable in some services provided by the government, but, just as clearly, not in all. This suggests that, even as the government may be bound to treat all its employees equally with respect to salaries, it can begin to implement plans for structural change involving processes and incentives in activities where the risks of collapse are not that great, or where back-ups and alternatives exist. We should not allow the "criticality" argument to act as a deterrent to change across all public services.

"Grandfathering"""the preservation of existing contractual obligations, while changing the terms of new contracts""is an essential, even if not entirely fair or equitable, instrument of change. The government has already done this with respect to the retirement benefits it provides to its employees. Those joining service after 2003 have shifted from a lifetime pension scheme to a provident fund, which means that the government's obligation to the employee ceases with the post-retirement payment of the accrued amount. Restricting changed terms of employment to new hires renders the process extremely slow; however, it can be speeded up by linking promotions to new terms as well. Employment may be guaranteed for a lifetime, but nowhere does this apply to promotions!

A critical objective for the SPC, even if it remains confined to the boundaries described above, is to effectively discriminate between skill categories in recommending pay hikes. It is well-known that the public sector pays more than the private at lower skill levels and substantially less at the upper end of the spectrum. It cannot, obviously, recommend that salaries are reduced, but it can, provided it has the political backing, put a lid on scales that are significantly in excess of market levels, while significantly narrowing the gap at higher skill levels.

In the ultimate analysis, what you pay for is what you get. The crisis of delivery in the public sector is a huge threat to the country's objective of inclusive economic growth. While raising public sector pay-packets is not an answer in and of itself, it is certainly an unavoidable part of any meaningful solution.

The author is chief economist, Crisil. The views here are personal