The new pay scale: Is a price hike inevitable?

Finally, the government has conveyed a 'financial greeting' to its employees on the eve of Victory Day through the gazette notification of the eighth pay scale. Though there are a few minor amendments since the last approval from the Cabinet Division, the smog of uncertainty is over at the end of the second quarter of the current fiscal year. The government will need to spend an additional Tk.191.07 billion to accommodate the extra pay this fiscal year and another Tk.274.18 billion in the next fiscal year for paying new bonuses and increments. Even though the new pay scale is going to work as a kind of 'rationalisation' for government employees, as they have long been perceived to be underpaid, its long term effect would be quite positive and intangible. It may now enable the government to attract talented people in the public sector.

The pay scale has already generated a lot of heat among the public and even among experts on its likely impacts on market prices. In fact, government pay scales are often associated with unwanted inflationary pressures in the economy, even though there is no empirical evidence on that claim. A closer look on the previous pay scales reveals that historically, government pay scales did not have any one-to-one relationship with inflation. From Bangladesh Bank data, it can be easily accessed that prices went down for a while after the third pay scale in August 1985 due mainly to a marked slowdown in the growth of liquidity and domestic credit.

On the other hand, there was a notable downward trend in price level after the fourth pay scale in April 1991 mainly because of price stabilisation measures by the government and decent performance in food production. In fact, the descending pressure on consumer inflation continued to go down for the next two and half years and there was a slight deflation in October 1993. Conversely, the price hike after October 1997 cannot be attributed to the fifth pay scale because prices were on the rise since early 1997. It was aggravated after the pay scale due to bad harvest during aman season that pushed food prices up, while higher fuel and electricity tariffs along with increase in loans to the private sector also facilitated an increase in the price of non-food items.

We also witnessed the sixth and seventh pay scales in the second half of the 2000s, followed by inflationary pressures. However, the growth of prices followed different paths after the two scales, and again, there is no ground evidence that the scales were responsible in increasing the prices. Price hikes after the sixth scale in May 2005 was due mainly to a disrupted supply chain of essential items, emanating from natural disasters, and higher prices of essential consumer goods and raw industrial materials in the international market. Still, the inflationary pressure was quite moderate and stable in the following two years. Conversely, the price hikes was too sharp after the seventh scale in December 2009 but again it was not due to extra money supply in the economy. Rather, it was mainly due to higher domestic food prices and rising prices of essential items in the international market, especially in India, which transmitted to the domestic market. The sharp growth of consumer prices continued for two and a half years and then started to decline. We are still witnessing the declining trend of general consumer price, which lasted up to November 2015, owing to a consistently 'contractionary' monetary policy. The government has been enjoying a comfortable position due to the effectiveness of the monetary policy, despite unprecedented political violence in December 2013 and the early months of 2015.

Therefore, it is believed, at least by a part of the expert community, that the eighth pay scale is unlikely to trigger price hikes since consumer prices have been on the downward move in the last two and a half years. Core inflation is quite stable due to growing aggregate supply to match the aggregate demand. Prices, including those of petroleum and food items, are quite stable in the international market. Thus, the strong foothold of the monetary policy in the real economy and impressive performance of the supply side of the economy would prevent inflation from moving up significantly for some time, despite significant growth of remittance inflow. 

Apart from empirical data, what does macroeconomic theory say about the effects of the pay scale on inflation? The quantity theory of money implies that given the level of velocity of money and gross output, injection of the additional money through the pay scale would increase the price level proportionately. However, the effect on inflation would be miniscule as the additional money required for the pay scale is only 1.12 per cent of GDP at current prices in the current fiscal year (assuming that this year's GDP growth rate would prevail). Instead, the national income effect would be nearly 4.5 times of the extra money through government spending multiplier if we assume that the level of domestic savings-GDP ratio of 22.3 per cent in the last fiscal year would prevail in the current fiscal year. In other words, this Tk.191 billion would not be lost in the heat of price hikes, rather it would revert to the economy worth additional Tk.857 billion.

In sum, the new pay scale is likely to bless rather than burn the economy if the other macroeconomic variables remain the same and no significant shocks appear in the external sector.

The writer is Senior Research Fellow at the Bangladesh Institute of International and Strategic Studies (BIISS).

E-mail:mahfuzkabir@yahoo.com