Salary increases and cost of living

A hype has been created with the increase in Government sector salaries from 1 July. The question arises whether the increase in salaries could be interpreted as a sign of astute economic management. 

Firstly, it should be assessed whether the salary increase could be justified.

Economic growth has been low

The economic growth from 2015-2018 is recorded at 5.0%, 4.5%, 3.4% and 3.2% respectively. The rate of growth is disappointing and the fact that it is on a declining trend is a concern. 

During this period, the average inflation has been 2.2%, 4.0%, 6.6% and 4.3%. Therefore the nominal growth (growth including inflation) has been around 7.5-8%. Therefore, one could justify an increase in Government salary bill by a similar rate. 

However, one should keep in mind that the growth in 2019 is expected to be even lower.

Increase in public sector salaries is not phenomenal

The data shows that the Government salary bill has increased from Rs. 455.7 b in 2014 to Rs. 646.8 b in 2018. It is expected to increase to Rs. 711.5 b in 2019 along with the recent salary increase. The resultant increase in salaries work out to 9.3% annually from 2015-2019. Therefore it is not too far off from the nominal growth of the economy of around 7.5%.  

But one should also note that only half of the salary increase is effective in 2019 (as it is implemented from 1 July) and the salary bill would increase by another substantial amount in 2020 while economic growth is exceptionally low currently. 

Government revenue and expenditure on a weak footing

The Government revenue and expenditure data in the first quarter of 2019 also paints a concerning picture. While Government revenue has fallen to Rs. 442 b from Rs. 469 b in the first quarter of 2018, the recurrent expenditure has increased to Rs. 576 b from Rs. 528 b. 

This is even prior to the impact of salary increases which would be felt in the second half of 2019. Therefore the recurrent expenditure is likely to shoot up in the second half of 2019. Meanwhile, the faltering economy with the Easter Sunday bombings could further dent Government revenue in the second half of 2019.  

Therefore the excess of Government expenditure compared to revenue is bound to expand significantly in 2019, even if the Government capital expenditure is reduced.

Cost of living to rise

This so-called “deficit spending” for consumption purposes (instead of appropriate capital expenditure which could result in a sustainable development of the economy) would only fuel inflation. 

When there is not enough growth in the economy to absorb an increase in supply of money (i.e. increase in salaries, etc.), the prices of goods and services tend to rise sharply. This is what is simply called the “rise in cost of living”. 

Role of ‘Cost of Living Committee’

The question arises regarding the role of the ‘Cost of Living Committee,’ which is possibly responsible to curtail cost of living from rising sharply. Often, we hear of this committee arbitrarily trying to control the prices of selected goods. However that is a futile exercise, as such a committee simply cannot control the supply and demand conditions of each item, which would determine the appropriate price.

On one hand, the demand is determined by the availability of money in the system, through measures such as salary increases. The supply could be determined by the economic growth. If the economic growth is poor, the availability of goods and services would be lower. Such a scenario results in too much money for lesser amount of goods and services, which results in prices going up – or cost of living increasing. 

Therefore the role of a ‘Cost of Living Committee’ should ideally be to monitor those supply and demand factors rather than arbitrarily changing the prices of selected items. On one hand, they should closely monitor the economic growth and suggest ways that it could be pushed up to more acceptable higher levels. 

On the other hand, based on the actual economic performance, the committee should recommend the level of salary increase that could be recommended, which would not result in a sharp increase in inflation or “cost of living”.

Inheritance for the next Government 

One could only hope that the ‘Cost of Living Committee’ would follow such a rational path and be more proactive in the future. 

But in the near future, it is not something that could be anticipated with elections close by. Increase in salaries was a must before the elections. Anyway, the resultant increase in cost of living would materialise later and that’s something to be tackled by the next Government next year. 

(The writers can be contacted via [email protected].)