Sources and Consequences of the Public Sector Premium in Albania and Sri Lanka

Across the world, the public sector pays higher average wages than the private sector for similar employees. Using data from Albania and Sri Lanka, the Growth Lab’s Ricardo Hausmann, Ljubica Nedelkoska, and Sehar Noor examined the factors behind public sector wage premiums. They found that in both countries, the government sector pays a premium for all, but its most skilled employees. For this group, the private sector pays better. Moreover, the government sector offers pensions, permanent contracts, and fringe benefits to the majority of its employees, as opposed to the private sector, where these are mainly reserved for the most valued employees. They show that the payment schemes of the public sector are primarily based on qualifications, where private sector wages are additionally influenced by person-specific characteristics, presumably negotiation skills and productivity. The research also shows that among the most valued employees (i.e., the highly skilled and highly paid ones), the best ones opt for the private sector. The best employees among the less skilled ones, opt for the government sector.

In this Growth Lab podcast, Research Assistant Jessie Lu interviews Ljubica Nedelkoska, Postdoctoral Research Fellow at the Growth Lab and co-author of this latest research on Public Sector wage premiums in Albania and Sri Lanka.

Visit our publications page to read the corresponding working paper.

Transcript

Katya Gonzalez-Willette: Hello and welcome to the Growth Lab at Harvard University's weekly podcast. 

KGW: Across the world, the public sector pays higher average wages than the private sector for similar employees. Using data from Albania and Sri Lanka, the Growth Lab's Ricardo Hausmann, Ljubica Nedelkoska, and Sehar Noor examined the factors behind public sector wage premiums. They found that in both countries, the government sector pays a premium for all but its most skilled employees. For this group, the private sector pays better. 

Ljubica Nedelkoska: The public sector is very well able to attract the best and the brightest among those with less than tertiary degrees, but is not very good at attracting the best and the brightest among its most skilled workers. 

KGW: In this Growth Lab podcast, research assistant Jessie Lu  interviews Ljubica Nedelkoska, Postdoctoral Research Fellow at the Growth Lab and coauthor of this latest research on public sector wage premiums in Albania and Sri Lanka. 

Jessie Lu: Thank you so much for being here with us today, Ljubica. So to start, I was wondering if you could tell us a little bit about the policy context in which you first approached this topic. 

LN: So back in 2016, the government of Albania actually already made a decision to increase the pay of the public sector, but they weren't sure by how much they should increase it and who should get how much in terms of a pay raise. So initially the government was thinking of using the public sector salaries in the region as a benchmark, which would have in most scenarios raised salaries for about 30-35 percent. However, we what we ask the government to do more is instead of comparing salaries in the public sector to public sector salaries in other countries to actually compare them to what the private sector in Albania pays for similar workers. So once we we started that analysis, we found out that if anything, on average, the public sector employees were paid above market wages and not below. 

JL: So given this sort of background in which you decided to look into wage premiums, could you talk a little bit about your findings? 

LN: Sure. Sure. So we looked at two countries. We looked at Albania where, as I said, we were asked to do so. And then we also looked at Sri Lanka, where we were also engaged in a applied research project. And we were looking more specifically into the labor market for university graduates. And since similar questions were raised in both countries, we kind of combined the study, and we found some very interesting similarities. So, for instance, in both countries, we found that the public sector pays above market wages, or in other words, has a premium pays a premium for similar workers. And this is the case for almost all employees except for the tertiary educated ones. Among the tertiary educated ones, especially the highly paid tertiary educated ones, so to say the most valuable employees of the public sector, we see that actually below market wages or a negative pay premium. Which then raised the question of, you know, what consequences this has for who decides to to work in the public and the private sector. 

JL: Great. So who does decide to work in the public and the private sector? 

LN: Right. So so that was the natural question. And maybe I should mention one thing more. So we didn't only look at wages in this case like net wages, but we also looked at the distributions of benefits. So the distribution of benefits, but also the existence of permanent contracts, usual working hours and also pensions. It's a very important part of the whole compensation package. And sometimes having a pension can dwarf whatever this public sector premium is. So it's a very important component of understanding who is rewarded, what and who has the incentive to work in the public sector. But we found that the patterns of pay premium are similar to the patterns of benefits. So the same groups that are paid above market salaries are also more likely to have permanent contracts, paid leave, to be paid pensions. So in that sense, the premium, it's not a compensation for lack of benefits, but they come on top of each other and all of that together suggested that the more able employees among the less than tertiary educated will have the incentives to work in the public sector, while the more able among the tertiary educated and especially the higher paid tertiary educated will have the incentives to work in the private sector. And when we studied the distributions of these abilities, that's exactly what we found. That's the kind of sorting you see. The public sector is very well able to attract the best and the brightest among those with less than tertiary degrees, but is not very good at attracting the best and the brightest among its most skilled workers. 

JL: So that's a pretty thought provoking finding from your research and since it's been a while since you first got the request to look into it, now that you have these findings - How would you change your policy recommendations to that Albanian and or Sri Lankan governments?

LN: Right. So that's true. Initially when we did the analysis, we didn't realize how much variance there was for different groups of employees. So since then, we have expanded the analysis. And I think what's very important is that the government's followed more closely what the private sector pays for similar employees and kind of tried to mimic those dynamics. Of course, many governments already are overpaying a large share of their employees, and it would be very unpopular to kind of reduce salaries. And in those cases, maybe one strategy that could work, at least in some places, is to get a little bit help of inflation. So instead of further raising the salaries, waiting for some of that value to depreciate at the same time, and in some places especially where the premium is negative for the most valuable employees, there might be need for more immediate action of raising those wages, since I believe the consequences of not doing so are costly. On the one hand, you don't want to be over smarted by the private sector in the key areas of policy. So imagine your ministers being less smart than the representatives of the industry. How would you expect them to regulate those industries? And on the other hand, you don't want to create incentives for corruption. Because we well know that government positions have a lot of political power. So you don't want to create pervert incentives for abuse of that political power. 

JL: Great. So, so far you've been talking about your research findings based on data that you've had on Albania and Sri Lanka, and I know that you've been involved in both of the Growth Lab projects in both countries and both countries have very unique backgrounds. So what does this diversity in context mean for the validity of your findings and their implications? What are the considerations that we have to take into account when we want to generalize these findings more broadly? 

LN: That's an excellent question, Jesse. So indeed, Albania in Sri Lanka, they do have some similarities. There are both upper middle income countries. They both have about 15 percent of all employees working for the public sector. But they're also widely different ethnically, in terms of government structure, in terms of the structure of their economies, and this is why we find it remarkable that the patterns are so similar. Luckily, we are not alone in this research. A lot of similar research has been done for other countries, both developed and developing. And again, the patterns that other researchers find are very similar. So overpaying for most employees and then either paying market wages or even below market wages for the top employees. So I think I can confidently say, based on our study and studies by others, that this pattern is visible around the world. An exception have been countries where due to hyper-inflation, the way the public sector adjusts their salaries, like with a long delay, where hyperinflation literally diminished the salaries of the public sector and the private sector being more dynamic as it is adjusted. So in these countries, what colleagues find is that across the whole spectrum of workers, the public workers were paid less. And in addition, they find that the way they compensated for that lack of income is bribes. So once they compared the level of earnings with the level of consumption, they all of a sudden found that their level of consumption was comparable to that of the private sector. And the only way to enable that is to have sources of income that were just not reported in the salaries data. So that's kind of a strong indication of what happens when you underpay your public sector employees. 

JL: Great, so I just want to stay on the global scale for this next question. I want to ask you, based on sort of your experience and your knowledge and what you've seen and current events, what are some exciting implications of these research findings on real world policy questions? 

LN: So it's very interesting. So Albania has not been the only country where there has been change in the distribution in the public sector. But for instance, in 2018, the incoming president of Mexico decided to slash his salary by 40 percent. And subsequently, the Mexican parliament passed legislation prohibits that any public sector worker is paid more than the president. So effectively, they capped the salaries on top. Similarly, in Kosovo less than a month ago, the incoming prime minister decreased his salary by 50 percent and did the same for all the cabinet members. And, you know, while these changes are very recent, I think what we will see and what is probably already happening in Mexico is that they're just going to lose some of the talent that they had within the top of the government to the private sector. So this shows that these changes are not something that was there in the moment when we did this study. But what we see in the news is more and more changes in the structure of pay in the public sector resemble or even more reinforce the pattern that we have seen in our study. 

JL: Well, that's very encouraging that your research findings have such wide applicability and are so relevant in this modern context. So thank you so much for talking to us both about the research and the process that you went through for that as well as the implications of it. I just want to end with a more open ended question and just ask you if in an ideal world, if you had all of the appropriate data, what would your next research question be on this topic? 

LN: So there are two issues that we have not been able to tackle. There is one implication of underpaying people in terms of sorting. But there is another implication of those employees that are kind of nominally underpaid, but actually stay the public sector because they find other sources of income using their political power. I think it would be very interesting to indeed match this data we have with data on actual consumption to see how much of underreporting of income there is and to see whether, according to our predictions, we indeed find more underreporting of actual income among those who are nominally underpaid in the public sector. So I think that would be a promising way to enhance and expand our findings. Another thing that I think it's very important and I don't have a straightforward answer to this, but in the context of countries like Albania, more and more as the country opens up, the outside option for public sector employees is not the private sector in Albania, but the private sector in the EU. And here the public sector faces much more significant problem of recruitment because an Albanian who would find a job in Greece or in Italy can immediately increase their standard of living and adjust their salary by multiple times like two, three, 4 times than what they would have if they would have stayed in Albania. So that's a far larger problem than the few percentage difference in the premiums that we see between the public and the private sector. And that's an issue I would like to study. 

JL: Great. Thank you so much, Lupita, for having this conversation and for telling us so much about your research. 

LN: It has been my pleasure. Thank you. 

KGW: If you want to learn more about the Growth Lab's latest research and events, please visit growthlab.cid.edu. See you next week.