Compensation for government jobs is higher relative to GDP per capita the poorer the country. In other words, government workers are most overpaid in poor countries. Excessive public-sector compensation in low- and middle-income countries distorts labor markets on two margins: queues (rent-seeking to win jobs) and misallocation (talent and taxes diverted from the private sector).
In my two posts Massive Rent-Seeking in India’s Government Job Examination System and The Tragedy of India’s Government-Job Prep Towns I drew attention to the first margin, rent-seeking losses from the queues. India’s most educated young people—precisely those it needs in the workforce—often devote years of their life cramming for government exams instead of working productively. These exams cultivate no real-world skills and entire towns have become specialized in exam preparation. I argued using a back-of-the-envelope calculation that the rent seeking losses alone could easily be on the order of 1.4% of GDP annually. More tragically, large numbers of educated young people are inevitably disillusioned. Finally, because pay is so high, the state can’t staff up; India has all the laws of a rich country with roughly one‑fifth the civil servants per capita.
Two macro papers quantify the other margin of loss: who ends up where.
In The unintended consequences of meritocratic government hiring, Geromichalos and Kospentaris (GK) look at the consequences of excessively high government salaries in Greece. In (MIS)Allocation Effects of an Overpaid Public Sector, Cavalcanti and Santos look at the case of Brazil. Both papers model the allocation of labor between the private and public sectors and focus on the cost of drawing too many high-productivity workers into government jobs.
GK summarize their results for Greece:
In many countries, public employees enjoy considerable job security and generous compensation schemes; as a result, many talented workers choose to work for the public sector, which deprives the private sector of productive potential employees. This, in turn, reduces firms’ incentives to create jobs, increases unemployment, and lowers GDP…. [Calibrating the model to Greece] we find that a 10% drop in public sector wages results in a 3.8% increase in private sector’s productivity, a 7.3% drop in unemployment, and a 1.3% increase in GDP.
CS report similar distortions in Brazil:
Our counterfactual exercises demonstrate that public–private earnings premium can generate important allocation effects and sizeable productivity losses. For instance, a reform that would decrease the public–private wage premium from its benchmark value of 19% to 15% and would align the pension of public sector workers with the one in place for private sector workers could increase aggregate output by 11.2% in the long run without any decrease in the supply of public infrastructure.
Interestingly, in the GK model there is no rent-seeking waste because workers are assumed to forecast exam outcomes perfectly and sort directly into private or public streams. In my India model, by contrast, the waste comes precisely from the years of futile exam preparation. GK also find that reducing the number of public jobs can raise efficiency, while my take is that in India high salaries make the public sector paradoxically too small (thus to some extent limiting misallocation). CS also focus on allocation but, unlike GK, they estimate that rent-seeking losses are massive—about triple my conservative estimate:
The aggregate cost of job applications to public jobs, which we label as the rent seeking cost, is large in the baseline economy…roughly 3.61 percent of output.
Across India, Greece, and Brazil the story converges: overpaying government workers distorts education, job search, and firm dynamics. The waste shows up as socially unproductive effort devoted to entering the echelons of government employment and a private sector which is drained of top talent causing it to be less productive and to grow more slowly. In short, rent seeking and misallocation from overly generous government compensation generate large macroeconomic losses. As relative compensation tends to be higher the poorer the economy, high government pay can be a development trap.
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