Pay Indexation in Pakistan

Pay indexation is usually linked with the cost of living, and the demand for pay raise is a consequence of high prices. We believe political regimes take pay raise as a popular decision and consider inflation an index for this decision. Factors like institutional framework, demographics of employees and share of wages in GDP including others are given due consideration; but inflation remains at the heart of all decisions. The precise indexation policy and experiences differ across countries. We observed that indexation to the price level and the frequency of wage adjustment go up with the level and volatility of inflation. For countries with high and volatile inflation, the desirability of wage indexation is an important policy issue when attention shifts to curbing that inflation.

As a matter of fact, there is no unique measure to be considered as inflation. Two of the Prevailing and contemporaneously used measures of inflation are core inflation and the rate of change of CPI (Consumer Price Index). Core inflation does not account for food and energy prices which are a primary concern of the general public, this makes core inflation less relevant. Luckily Pakistan Bureau of Statistics (PBS) issues three price statistics; SPI (Sensitive Price Indicator), CPI (Consumer Price Index) and WPI (Wholesale Price Index) with distinct frequencies and different combinations of goods and services from luxurious items to staple food. It is fair enough to believe that CPI and SPI are more relevant than WPI to provide estimated inflation for retail consumers.

CPI basket includes luxurious items while SPI based on basic necessity items. About 60% of the population falls in the “transitory poor” category (Bukhari and Haq, 2019) it means a substantial population has no access to luxurious items; their needs revolve around basic necessities. The rules for indexation to the CPI have several potential disadvantages. They prevent real wage and employment adjustment in the presence of real shocks, causing suboptimal employment. In the presence of nominal shocks and inflation, indexation to prices can generate inconsistencies. The shock of inflation is not uniform for basic and luxurious commodities. The inflation through CPI is not suitable to be used for indexation as it cannot capture the inflationary shock to all income groups.

Pakistan Bureau of Statistics (PBS) reports SPI at weekly frequency and CPI on a monthly basis. Being lesser frequent, CPI (12 points per year) is incapable of capturing the price fluctuations which might fade out over the period of a month, while more frequent SPI (52 points per year) captures price volatility much better than CPI does. This makes SPI a more representative indicator than any other price statistics. Recent research at PIDE related to SPI reveals that inflation volatility causes inflation (Cukierman-Meltzer hypothesis), in other words, the prevailing general perception about high prices triggers prices even higher. This directly reduces actual income and affects fixed salaried persons. We propose using inflation indexing in pay raise decisions and also using SPI (Sensitive Price Indicator) to calculate inflation; instead of core inflation or rate of change of CPI.

We use SPI data for the year 2020 (current) and 2019 (base) to calculate inflation rate that can be used as an index for pay raise in the Federal Government budget 2021-2022. All SPI quintiles along with combined SPI remained higher in year 2020 than year 2019 (all 52 weeks), reflecting the persistent price hike over the period (Fig.1).

We map distinct basic pay scales to appropriate SPI quintiles (Table.1).

We calculate the rate of change of each SPI quintile in year 2020 with 2019=100 and find the mean, median, maximum and minimum change over 52 weeks and suggest percentage increase in initial basic pay of all basic pay scales’ categories (Table.2). We observe that prices are higher in lower income quintiles than higher ones. The government can choose any proposal or mix of proposals accordingly.

MC = Mean Change, MdC = Median Change, MxC = Maximum Change, MnC = Minimum Change

We conclude that Pay Indexation using SPI inflation is an appropriate and simple technique to propose pay raise of government employees of distinct pay scales. This simple technique can be used for years to come and can even be changed as per need and intention of government. Given the same basic pay scale system, the study also applies for Provincial Government Employees.

It is a general perception that pay raise is a burden on budget, but a recent study at PIDE reveals that a unit increase in nominal income increases direct taxes by over one unit (PIDE, 2019). This finding is crucial in the scenario when governments are eager to increase tax revenues.

References

1. Bukhari, H., & Haq. I. (2019). Rich-poor widening gap Business Recorder, Viewed at https://fp.brecorder.com/2019/02/20190222449162/
2. PIDE (2019) “Economic Management Modeling in ECO Member Countries”, Joint PIDE-ECO Project Report, PIDE, Islamabad.
3. “The Federal Minimum Wage Indexation”. Congressional Research Service (2016)
4. Zeeshan Hanif and Saud Ahmed Khan 2020. “Analyzing the Uncertainty of Sensitive Price Indicator: Evaluating the Friedman-Ball and Cukierman-Meltzer Hypothesis in Pakistan Economy”, PIDE, Islamabad.