- Fiscal deficit: The impact on the central government is 0.46% of GDP which reduces to around 0.4% of GDP once taxes are taken into account. A correct way to look at the impact is to amortize this impact over a business cycle. If amortized over, say, five years, the annual impact is a piffling 0.08%
- Output and growth: Government spending on pay will rise. Analysts think this will be expansionary as it was during the time of Sixth Pay Commission. They are wrong. On the last occasion, higher pay was allowed to translate into a higher fiscal deficit. This time, the finance ministry has said the targeted reduction in fiscal deficit from 3.9% of GDP in 2015-16 to 3.6% of GDP in 2016-17 will be adhered to. This means that increased pay will be offset by reductions on other accounts. The pay hike will, therefore, not be expansionary
- Inflation: For the same reason as above, the pay hike will not have a significant inflationary impact
- Sectors: Higher spending by government employees can provide a modest stimulus to sectors such as real estate, consumer goods and automobiles. The stimulus will be modest because the increases in pay are not very large.
Critics of Pay Commissions have said that the tail is government is too long and the head too small. This can change if the government wishes. There will be large retirements in the C and D categories. These can be left unfilled and the government can instead hire in larger numbers at the officer level. In the years ahead, there is a great opportunity to right size the government and bring in diverse skills.
Overall numbers have been growing mainly in the ministry of home affairs (police and paramilitary forces), not so much in most other ministries and departments. The SPC provides data that shows that India's bureaucracy in relation to the population is much smaller than that of the US.
The other criticism of Pay Commissions is that they have not emphasised performance and productivity adequately. The Sixth Pay Commission had proposed a performance-related incentive scheme (PRIS). The SPC notes that it hasn't quite taken off because of numerous operational difficulties. It also notes correctly that performance measurement in government is rather difficult. It is less difficult in the private sector where performance can be measured against defined commercial targets (although even this is done badly in most private firms). The SPC proposes performance related pay linked to a new framework.
My sense is that operationalising this framework will prove just as difficult as the Sixth Pay Commission PRIS. The focus in government should be primarily on collective performance as measured by independent audits, the reports of which are made transparent. There should be penalties for collective under- performance (such as delayed promotions and even compulsory retirement). Financial rewards for good performance should be for a team as a whole and the amounts should be quite modest. Anything else will create havoc in government.
There is a strong case for creating a separate management audit department in the CAG. All government departments, agencies, regulators and autonomous institutions must come under its purview. The management audit should focus not just on outcomes but also on internal processes and governance and should cover HR issues. Where processes and governance are weak, it will be reflected in outcomes. A management audit should capture these before outcomes are undermined.
More on the SPC report in my article in the Hindu, Why we must not grudge them a pay hike