How public sector pay and employment affect labor markets : research issues

Structurally, the public sector has a more important economic role to play in developing countries than in industrial countries, particularly in how it affects labor markets. Evidence from many developing countries shows that public sector pay, employment, and performance are hurting the labor markets'ability to allocate workers among sectors and skill requirements. In many countries, the civil service and the public sector wage bill have grown to unsustainably high levels. The public sector is so big that interventions in the sector - with or without spillover effects into the nonpublic sector - make it more difficult for wages and employment to respond to shifts in demand and supply. Nonwage benefits are seldom related to productivity, so they can be particularly distorting. At the same time, a long-term drop in real civil service wages and the compression of wage ranges have caused critical shortages of managerial and technical workers in the civil service. The resulting skill imbalances in the rest of the domestic economy reduce international competitiveness in some countries. Policy reform has focused on the reform of large, inefficient public sectors because of their cumulative negative effects on economic growth and competitiveness. Policies to adjust relative prices from nontradables toward tradables have led to some movement of employment out of the public sector, but significant rigidities remain. Workers are attracted to the public sector because of complex economic and social incentives that are difficult to change - and the relationship between public sector interventions and the underlying political and economic forces is an important area for research. The slow progress in restructuring the public sector in many countries highlights the needto address more forcefully and more subtly how public sector policies affect the labor market.