Discussion Paper No.169 of 2014 on the Sustainability and Macroeconomic Effects of the Public Sector Wage Bill in Kenya

Abstract

The size of the public sector wage bill has been a central issue of concern to the government recently. Management of the public wage bill is important for overall budget sustainability more so because it the wage bill constitutes about 30 per cent of total government expenditure and has increased from Ksh 215 billion in 2008 to Ksh 389.5 billion in 2013, representing an 81.2 per cent change. In 2013, the wage bill as a per cent of GDP was 10.3 per cent, which is higher than the ratio for most East African countries and the internationally desirable level of 7.0 per cent. The objective of this study was to determine whether the public sector wage bill is sustainable. Data used in the study is time series from 1982 to 2012 from the Kenya National Bureau of Statistics and 2012/13 data from the National Treasury. The Johansen cointegration test is used to assess the wage bill sustainability, while scenario analysis using the KIPPRA-Treasury Macroeconomic Model (KTMM) is used to assess the macroeconomic effects of public sector wage bill. The results of the Johansen co-integration tests (both the trace test and the maximum eigenvalue test) at 5 per cent level of significance show that the variables were not co-integrated. The results using KTMM showed that an increase in government remuneration has effects on volume of consumptions, imports, GDP at market rate, current account, domestic debt and financial deficit. The finding from the cointegration suggests that Kenya's public sector wage bill has no long run relationship and, based on this finding, the study concluded that Kenya's public sector wage bill is in violation of its inter-temporal budget constraint and, therefore, unsustainable. Simulations using KTMM showed that the effects of increased government remuneration by 25 per cent in 2012/13 would affect macroeconomic indicators responsible for macroeconomic stability. The fiscal deficit would widen, current account balance would worsen, and increase public debt. The study recommends that the government reduces the public sector wage bill by developing a public sector wage policy, optimally utilize the existing human resources in public service, undertake job evaluation for all cadres of public sector employees, and fast track legislation on allocation of revenue to various expenditures.