Another pay commission? The government should hold its horses

There is also a built-in expectation that the Pay Commission will merge dearness compensation with basic pay, since the overall dearness compensation is now at 50% of basic pay, along with an additional increment on account of fitment. This merger will allow the revision of all other allowances as well.

From the point of view of employees seeking higher wages for themselves, such a demand is not surprising. However, it is worth asking if meeting this demand is necessary, or even desirable.

Also read: Data check: Why C-suite salaries jumped in FY24—and did staff pay keep pace?

There are many aspects to this, the most important being whether there is a need for revising pay at all, given that government employees already receive full compensation for cost-of-living increases, as measured by the Consumer Price Index for Industrial Workers (CPI-IW), apart from regular annual increments and periodic promotions that assure them career progression.

It may, in fact, be argued that the system of dearness compensation over-compensates government employees, because it is calculated on the basis of the CPI-IW. This price index is computed on the basis of the consumption pattern of the ‘average’ worker, who typically earns less than a government employee.

The method of revising compensation is to increase the salary in line with inflation; in other words, it is to allow the employee to continue to be able to afford the basket of goods which underlies the index.

In economics, this form of compensation is called ‘Slutsky Compensation.’ Economics 101 teaches us that this form of compensation leaves the individual better off after a bout of inflation because it does not factor in the adaption of consumption patterns in response to changes in prices.

In simple terms, as some items become more expensive, people adjust consumption. For example, if tomatoes become very expensive, they are often substituted with other souring agents (like tamarind or kokum).

Such adjustment are dynamic and evolve with changing price behaviours—new items of consumption are introduced and old items removed. This is routine human behaviour.

Also read: The big shift from salaries to bonus-based pay

In fact, because this compensation does not account for changing consumption patterns due to changes in relative prices and individual preferences over the years, compensated individuals actually see a rise in their standard of living.

A large part of the inflation in recent years has been on account of the rising prices of food items. However, as incomes rise, the share of food in total expenditure declines. Thus, people with incomes higher than that of the average industrial worker will typically have a consumption basket with lower dependence on food.

For them, a pay-hike principle based on the CPI-IW results in over-compensation for a rise in prices, with the extent of it increasing as income levels rise. Even the typical entry-level government employee is paid much higher wages than most industrial workers are.

So the primary beneficiaries of any salary hikes awarded by a pay commission are seeking to ‘lock in’ this privilege even further.

It is worth recalling that India’s early Pay Commissions were not blind to this form of inequality, and used to recommend a sliding system of inflation adjustment in order to ensure lower adjustments at higher income levels. Unfortunately, due to the high inflation experience from the mid-70s onwards, this principle was forgotten.

These types of biases in compensation get further exaggerated because of long gaps between index revisions (the base year of the current CPI-IW series is 2016) and rapid changes in consumer preferences taking place due to the introduction of new forms of consumer goods and services.

If we were to adjust properly for all these factors, a case could be made that most government employees need pay reductions to align their standard of living with what they might have reasonably expected when they joined government services.

The point of this argument is not that government employees should not expect reasonable increases in pay, nor that inflation compensation should not be done.

However, ideally speaking, pay should be set on sound market principles that relate to both work productivity and earning levels outside government employment, and factoring in the structural rigidities built into a system where positions once created are almost impossible to remove.

Pay Commissions create problems on fiscal management, with their pay-hike recommendations constraining budget allocations for different developmental needs. These constraints are further magnified by the fact that state governments and autonomous bodies are expected to match Central government pay scales.

Also read: India’s IT services firms tighten their wage belts. But are they getting fitter?

The burden of this spending has become so heavy because of the enormous expansion of the government. In 2021-22, the Union government spent ₹7.9 trillion on the salaries and pensions of civilian and defence employees, a sizeable 22.7% chunk of a total central budget of ₹34.8 trillion.

This proportion rises even more if the employees of autonomous bodies and subordinate establishments are included, leave alone the state governments and establishments attached to them. The problem of a large wage bill is compounded by over-staffing at the headquarters and lower levels, with inadequate allocations for more functional positions.

What India urgently needs today, therefore, is not another Pay Commission to hand out salary increases, but an overall manpower assessment and pay rationalization.

The author is a former chief statistician of India.