Annex -1 - World Bank



Analysis of the Recent Downsizing Effort in Sri Lanka(

This case study describes a recently announced but not implemented, across-government downsizing exercise in Government of Sri Lanka (GoSL), which was supported by the Bank’s PRSC I. Government offered a Voluntary Retirement Scheme (VRS) to employees 50 and older. They could retire, receiving full salary until age of retirement, and pension thereafter. The case draws parallels between the present effort and an earlier unsuccessful effort at downsizing supported by the World Bank’s 1990 Economic Restructuring Credit.

Why did the Government opt for large-scale retrenchment?

GoSL opted for downsizing its public sector as a response to a fiscal crisis arising, in part, from rapid growth of public sector employment. This action was taken after attrition, recruitment freeze and similar less-painful strategies were ineffective in controlling the wage bill.

Sri Lanka’s public sector dominates the economy, with 3.6 civil servants for every 100 of its population in 2001 The public sector comprises (i) Federal Public Service, (ii) Provincial Public Services, and (iii) Treasury-funded agencies. The employees are broadly divided into four categories based on range of pay scales and responsibilities. Group A comprises officers including those of All Island Services, Group B comprises staff officers or executives, Group C comprises clerical support staff, and Group D represents blue collar workers. Employees in Groups C and D groups constitute 88% of public sector employment.

During 1990-2001, public sector employment grew rapidly: Table 1 below shows an average annual rate of 3.5%. This rate of growth was nearly three times the rate of population growth during the same period. Between 1998 and 2002, central employment growth (23.5%) was nearly double the growth of GDP (12.2%). An earlier retrenchment, funded by the Bank’s Economic Restructuring Credit of 1990, had been counter-productive: the number of employees and ministries increased immediately following the downsizing.

Table 1. Growth in Public Sector Employment in Sri Lanka

|Sector |1990 |2001 |Increase |Total increase |Average Annual |

| | | | |as % of base |Growth Rate (%) |

| | | | |year | |

|Federal Public Service |198,425 |303.331 |104,906 |52.9 |3.93 |

|Provincial Public Service |222,584 |286,461 |63,877 |28.7 |2.32 |

|Treasury-funded Statutory Boards and |60,000 |118.000 |58000 |96.7 |6.34 |

|Corporations | | | | | |

|Total |481,009 |707.792 |226,783 |47.1 |3.57 |

Source: Report of Salaries Commission, 2001

GoSL experienced fiscal crunch during the very late 1990s and during the early years of the new millennium, when the annual budgets’ deficit financing were between 7 to 12% of GDP. The 8.1% (of GDP) fiscal deficit of the 2003 budget was unsustainable. The Fiscal Responsibility Act, 2001 targeted steady lowering of the budget deficit, and bringing it to under 5% in 2006. The Act also mandated that GoSL contains it current expenditure to 3% of GDP, and achieves this via reductions in wage and interest expenditure. The weight of the wage and pension bill has crowded out priority expenditure in education, health and essential infrastructure, and even operational expenditure necessary to enable employees’ effective functioning. If current trends continue, by year 2010, government revenue will be completely absorbed by wages and pensions.

Actions less drastic than retrenchment failed to control steady growth in public employment. A hiring freeze had long been in effect, and was extended to hiring of casual workers[1]. To slow down new recruitment, GoSL abolished all vacant posts in 2000: 4700 vacant posts were abolished in the All Islands Service, as were 3200 excess positions of Sinhala teachers i.e., teachers who teach in Sinhala medium. The finance ministry’s budget department limited budget provision in the salaries head to 2002 levels, thus discouraging the creation of any new posts. Yet, as shown in Figure 1, a growth spurt in public employment occurred during 2002 and 2003.

Administrative crises accompanied the fiscal crisis. Overstaffing, administrative fragmentation, low productivity in public sector and politicization of recruitment have ailed the public sector since the 1980s. These were highlighted in several reports submitted to GoSL—including the Administrative Reform Commission’s 1987 report; the 2001 ‘Regaining Sri Lanka’ report by the Treasury Department, and the Cabinet Memorandum of 2004. While implementing reactive responses to an out-of-control wage bill, GoSL made no proactive attempt at reforming recruitment and human resource management, nor in the control of political micromanagement. In 2002, the Treasury advised all departments to undertake functional reviews with a view to task-consolidation and identifying redundancies. But this was not followed seriously by any department. Only the Central Bank initiated functional review, and subsequently designed and implemented a Voluntary Retirement Scheme (VRS).

Was there adequate planning for the downsizing effort?

In 2004, GoSL announced salary and pension increases to all employees, with the biggest increments benefiting lower and middle level employees. Very soon thereafter the Treasury announced a Voluntary Retirement Scheme (VRS), which targeted the reduction of employees 50 or older.

The present VRS’s design did not draw upon the lessons of the previous Bank-supported VRS. The Bank’s Project Completion Report (included in the course pack) cited the earlier exercise as an example of how retrenchment programs can go wrong. Yet, elements of the previous design that had contributed to its lack of success were repeated in the current exercise.

As in 1991, the VRS was unlinked to any broader reforms of the central and provincial governments and rationalization of their functions. The severance payments were equally overgenerous. As before, the new VRS built no safeguards against adverse selection. Earlier many skilled staff had left while the deadwood stayed on. The vacuum created by the departure of experienced staff and skilled personnel, including specialist doctors, had had to be filled by hiring consultants, many of whom who had taken the early retirement package. As pointed out in the Bank’s Project Completion Report, the problem had not been one of wrong diagnosis, but that of faulty design, implementation and monitoring of the scheme, while ignoring the need for eliminating obsolete functions. Paradoxically, Sri Lanka’s own 1987 report Administrative Reforms Commission had warned against piecemeal implementation of the program and the likelihood of chaotic results.

The VRS had neither a strategic objective, nor demonstrated any fit with Cabinet Memorandum’s broader agenda for public service reform. Was the fundamental objective one of financial savings or improved performance? Did GoSL want to reduce the number of ministries, or the number of cadres, or in staff in selected cadres? Was the VRS meant to get rid of inefficient staff, or bring in new skills? It was not enough to merely relieve 300,000 employees from service without the purpose of the exercise or what the following steps would be.

The VRS had been hastily devised and suffered from legal lacunae. Government’s own top legal officer, the Attorney General (AG), was not consulted before the announcement. The Treasury’s circular did not include a negative list of who could not opt for VRS, nor any other enabling exclusion clause that would prevent adverse selection. This would result in loss of critical staff skills (e.g. specialist doctors, paramedical staff, subject matter teachers, and experienced managers). The use of arbitrary criterion like ‘first come first served’ instead of a legally acceptable criterion for priority such as applicants’ seniority in service was likely to be challenged in court.

The VRS’s design was constrained by limited diagnostic and analytic work. Only after Treasury had issued the VRS circular, did GoSL recognize that the Establishment Code needed amendment[2]. Although the Bank’s concern about administrative reform and its dialog with GoSL had resulted in the planning and initiation of analytical work funded by the Bank’s TA, only one of those proposed studies (on establishment control) was undertaken because of lack of initiative from Administrative Reforms Committee.

Inadequate advance planning prevented steps that could have complemented the VRS, and reduced downstream costs. These included:

• Control over abuse and extent of overtime payments,[3]

• Use of available provisions to remove undisciplined or poorly performing staff,

• Compulsory termination of casual and contract workers instead of leaving the door open for their regularization;

• Exit of staff serving beyond retirement age by scrutiny of personnel records:

• Census of the civil service and payroll audit to eliminate ghost workers; and

• Building implementation capacity of Treasury, Ministry of Personnel Administration and key departments

The government could have (but did not) studied the successful VRS of the Central Bank that reduced staff strength by more than half, while excluding senior management and skilled staff. The scheme withstood legal challenges and realized tangible benefits. The success was followed in the Port Authority, using similar methods.

How was resistance addressed?

Government addressed resistance from employees’ unions mainly by avoiding compulsory measures and holding out generous severance packages far superior to those offered earlier to downsized state owned enterprises.

There was apathy to this VRS from within government itself. Only the Treasury owned the VRS; no other ministry had any incentive to collaborate with the Treasury to effectively implement the scheme. GoSL overlooked the administrative capacity needed to manage the process, and the likely legal obstacles. The Treasury circular demanded a huge effort from each ministry to identify the redundant cadres and posts, and to manage the receipt and processing of applications along with attendant legal challenges from powerful staff associations. The ministries themselves had little professional support for the exercise and were further not sure of political support from individual ministers.

Although lack of consultation within government had harmed the previous VRS, the present one did exactly that. It was designed by the Treasury and a small group of ministers without prior consultation and subsequent involvement of line ministries. Line ministries, including the Ministry for Public Administration responsible for HRM, and Provincial Councils were not involved in the drafting of the VRS. At a meeting convened by the Chairman of the Administrative Reform Committee (who was also Secretary to the Prime Minister), senior line ministry officials expressed misgivings about the circular -- including its risk of adverse selection and aggravation of skill shortages. Communicating the rationale of downsizing to a wider group of line ministries could have obtained support from individual ministers. Failure to consult the Attorney General ahead of the scheme’s announcement left GoSL unaware that Constitutional provisions required it to introduce the scheme in provincial councils in the name of national policy.

There was no IEC strategy to support the VRS. The media projected the VRS package as a pre-election bonanza rather than as an element of downsizing. The public was cynical about the exercise because government expanded simultaneously with the VRS offer, and patronage-based recruitment continued. Four ministries were established for regional development though the Constitution devolved this responsibility to the Provincial Councils.

How was staff reduction targeted?

By January 2002, the size of public employment—excluding the army and SOEs—was 736,000 of which about 90% were in groups C and D, as charted in Figure 2 below. The largest groups were the teachers (180,000), police (54000), and health staff (22000).

Figure 2. Public Employment in Sri Lanka

The VRS was inconsistent in who was being targeted to leave. Although the objective was to reduce staff strength in lower and middle levels, Treasury’s circular announcing the scheme was open-ended on numbers and categories of staff.

Instead of advance preparatory work on different what-if scenarios and the costs thereof, these figures were expected to emerge from the work of VRS Committees after the scheme had been announced. Such committees would be set up for each Ministry or a group of small Ministries as well as each provincial Council. The committee would be headed by the most senior permanent secretary and comprised heads of departments and technical secretariats. The committees would decide whose VRS application would be accepted. The process would be overseen by the High Powered Steering Committee in the Treasury.

The VRS’s target was to reduce the workforce of 736,000 by 100,000 by 2004, and by a further 200,000 by 2006. There would be additional, indirect savings in housing loans and employee welfare payments. It was expected that the number of VRS acceptors would retroactively fit the targeted reduction number. The Treasury assumed that all employees eligible for VRS would apply by the prescribed date, but made no provision in the budget for making VRS pay-outs to those who applied for the scheme. The wage bill was estimated to diminish by 28.7%, still leaving GoSL with 3.76 public employees per hundred population, which was 29% above the 1990 level.

How did the VRS package balance between attractiveness to employees and cost-effectiveness for GoSL?

The cost of the VRS package rose on account of

Government’s announcement, ahead of the Salaries Commission’s report, of an across-the board increase of 10% (the increment was higher for agitating health workers) or Rs.1250, whichever was higher[4]. This raised the estimated front-end payment from Rs. 8 billion to Rs. 11 billion.

Previously awarded allowances (interim allowance of Rs.1200 in 2000, and salary interim allowance of Rs.1000 in 2001) being incorporated into each scale’s base salary, thus increasing the pensionable salary for VRS optees.

Forgiving repayment of employees’ loans would cost roughly Rs.7.2 billion from 2004 to 2007[5].

The conservative estimate of the VRS payments’ net present value was Rs.28.4 billion ($296 m) during 2004-2007 or Rs.94635 ($986) per retrenched worker. Instead of being offered to all employees, if VRS were restricted only to target Groups C and D, salary savings would be around Rs. 6 billion per year for 100,000 employees or a net present value of Rs.47.5 billion through 2007. If many group A and B employees are allowed to exit via VRS, the estimated costs would rise to $1272 per worker.

Although the per employee payout appears modest compared with VRS costs elsewhere[6], the difference is that GoSL will not save any amount on account of reduction of wage expenditure. Those opting for VRS would continue to receive fully salary. Elsewhere, VRS acceptors have been terminated, and receive retirement benefits instead of salary.

For example, in 2002, the Indian state of Orissa announced an open-to-all-employees VRS scheme that was partially supported by DfID. It offered ex gratia payment of only 21 days of basic pay and dearness allowance for each completed year of service subject to the amount not exceeding the emoluments for the remaining period of service. Further, no pension was payable, not any compensatory payment made, to those those who had served less than 10 years. This is being partly supported by the DFID. The VRS scheme offered in 2003 by the Indian state of Karnataka was limited to redundant staff. It gave higher ex gratia payment than Orissa (35 days for each year of completed service and 25 years for balance period till retirement.)

Based on zero growth in non-core staff for six years, the Treasury calculated a payback period of 7 years at the discount rate of 10%, inflation rate of 6% and the estimated annual growth of 6% in nominal wages. Projected savings used for NPV and IRR calculations were notional but illusory in cash terms. Pension savings were calculated taking VRS optees’ pensionable salary as the basic pay drawn at the time of VRS and not the pay level they would have reached at the time of retirement. Salary savings were counted from not having to pay increments and inflation-indexed allowance the employee would have drawn had (s)he continued in service till retirement. The projected inflation rate was a critical part of the calculations. As part of savings, government also counted loans that the employee might have taken for house building or vehicle purchase etc. Accelerated loan recovery was counted as part of the upfront payment of the VRS package.

Table 2. Costs and savings of the present VRS

The Finance Minister’s budget speech cited a number of indirect savings from VRS without quantifying them. These included the savings on promotion pay and annual increments for VRS optees, savings on house-building loans to employees, and O&M expenditure.

An interesting response would be to compare the announced option with the alternative of doing nothing. By simply maintaining a firm hiring freeze, a modest attrition rate of just 1.5% (allowing for essential recruitment) would produce a reduction of nearly 40,000 employees by 2006 (13% of the planned reduction) with no additional separation costs for government. If departments responded to staff reductions by granting overtime to remaining employees, salary expenditure would rise higher than projected.

How did the VRS’s design mitigate the hardship of retrenched employees?

Transitional assistance was not planned for exiting employees The perception was that the very generous severance package would equip them for self-employment or be utilized towards retraining for a career in the private sector. There was no consultation (as had been in the Central Bank) with staff unions on the requirement of transitional assistance or help in investing the severance payment. Following Treasury’s 2004 circular announcing the VRS, many Secretaries in GoSL advocated counseling, job placement and retraining assistance to retiring employees. No surveys of employees appear to have been undertaken before and after separation.

Epilogue

On the eve of elections in April 2004, the government decided to defer implementation of VRS till after the elections and asked the Finance Department to initiate necessary advance action. After the elections, a different coalition assumed office with a lean majority. VRS appears to have been put on the backburner. It is not clear if the proposal will be revived in the near future.

References

1. Beschel, Robert and Pachampet Sundaram. 2002. Rationalization of manpower in Indian Civil Service. World Bank. Washington DC

2. Government of Sri Lanka. 1987. Report of Administrative Reforms Commission. Ministry of Public Administration and management Reform. Colombo

3. 2001. Regaining Sri Lanka. Treasury Department. Colombo

4. -------------------------------. 2004. Voluntary Retirement Scheme. Treasury Department. Colombo

5. -------------------------------. 2001. Report on Revision of Salaries of Public Service. Treasury Department. Colombo

6. World Bank. 2002. Implementation Completion Report for the Sri Lanka Economic Restructuring Credit (2128-CE). World Bank. Washington DC

7. Haltiwanger, John and Manisha Singh. 1997. Cross-country evidence on public Sector Retrenchment. World Bank. Washington DC

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( This case study was prepared by Pachampet Sundaram, consultant. The text does not necessarily reflect the views of the World Bank.

[1] New post creation by a federal ministry or provincial council by way of adding to the authorized cadre strength, or absorption of a temporary post into the permanent cadre, or re-gradation of a post, or changing the rate of pay, required the requesting unit to complete Financial Regulations Form F.R. 71, justifying the duties, job description, and rationale to obtain Treasury’s approval for post creation.

[2] The amendments to the Establishment Code related essentially to ensuring the integrity of the recruitment process and preventing reentry of retired employees in the garb of advisers. It was also possible to (a)expand the list of persons disqualified to apply for government posts under existing provision in Rule7; and (b)empower the Public Service Commission in exercise its statutory powers to prevent irregular appointments and regularization of temporary workers. The Treasury endorsed the need for a law to control unauthorized appointments as was done through legislation in Andhra Pradesh state of India.

[3] This could have prevented growth of salary expenditure and neutralized the effect of overtime payment for group C and D employees, and could also have been factored into the VRS cost calculation

[4] The salary hike would cost GoSL an additional Rs. 12.5 billion in 2004, representing a 2% rise in GoSL’s recurring expenditure, going up from 26.6 to 28.5% of recurring expenditure, even without similar pay increase in SOES and local government. The proposed increase would benefit the lower levels of civil servants more than the upper levels (20% increase to group C against 10% increase for group A). The increase would further reduce the compression from 8:1 to 6.2: , thus reduce skilled and senior staff’s incentive to remain and urge them to opt for VRS.

[5] This is the period over which the employees would make one time payments and others would be given compensating payments for loans not taken.

[6] Haltiwanger and Singh 1997 reviewed 41 retrenchment efforts across 37 countries and found the payment of $17000 per worker in public enterprises in India over 1993-94 to be nearly eight times higher than the average cost per worker paid in other South Asian countries such as Pakistan and Sri Lanka. This particular exercise may have been on the high end, but it is also likely to be much more difficult to lure staff away from the core civil service than a sick public enterprise. Karnataka Administrative Reforms Commission worked out Considering only the lowest scales in each group, it works out to about Rs. 800,000 for Group A ($17,391); Rs. 471,000 for Group B ($10.239); Rs.302,000 for Group C ($6,565); and Rs. 174,000 for Group D ($3,783) see also Beschel and Sundaram 2002

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Box 2. The previous Bank-supported VRS in Sri Lanka

In 1989, GoSL employed about 500,000 persons in 26 ministries. In spite of low wage levels, the salary bill constituted 6% of GDP or a third of government revenue. Administrative effectiveness was eroded. Retrenchment was justified on fiscal and administrative grounds.

A VRS with very generous severance package was financed through support of a World Bank project and other sources.

By 1990-91, about 43,000 government employees had left. Yet, by end 1992, instead of reaching the projected target of 440,000, 100,000 more persons were hired, central government employment had climbed to 550,000, the number of ministries had doubled to 51 and the combined wage and pension bill had risen substantially. The VRS left a lasting legacy of enhanced pension at 90% of the last drawn pay.

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Box 1. Features of the announced VRS

Targeting: VRS was offered to all employees, although GoSL intended reduction in middle and lower grades.

Processing: Employees’ VRS applications would be processed on a ‘first come first served’ basis. (It was subsequently suggested that the seniority criterion be applied instead.) Based on recommendations of departmental committees, a high-powered steering committee would select which posts’ incumbents would be offered VRS. The same committee would take final decision on which VRS applications would be accepted

Additional benefits to make retirement ‘voluntary’: (i) Up-front payment of twelve months compensation (salary plus recent increments); (ii) monthly payments equal to the employee’s compensation at current rates of pay and dearness allowance till (s)he retires at 55; (iii) Payment of applicable pension on the basis of basic pay at the time of VRS to approved employees after retirement age while providing lump sum compensation to those with less than pensionable service; and (iv) Write-off of outstanding distress loans up to Rs.24000 and equivalent compensation to those not having outstanding loans to bring them on par;

Oversight: Appointment of a Steering Committee to oversee the process of determining the number of employees in various staff categories in each Ministry, based on recommendations from committees at the level of Ministries and Provincial Councils

Prevention of rehiring: Employees opting for VRS could not subsequently accept any post in public service; the Treasury would maintain a database of retiring employees along with their national identity numbers; it would require all recruiting authorities to take Treasury’s approval before all future recruitment and consult the Treasury’s database of retired employees.

Figure 1. Recent Growth Spurt in Public Employment

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