What Goes up Must Come Down — Cyclicality in Public Wage Bill Spending

Abstract

This paper analyzes the cyclicality of public sector wage bill spending in Europe and Central Asia and assesses the impact of wage bill spending on fiscal discipline before, during, and after the global financial crisis of 2008/09. While there are important differences across countries, the results show that public sector wage bill spending tends to behave strongly pro-cyclically, especially in transition economies. Moreover, while wage bill spending is pro-cyclical during both good and bad times, adjustments during economic downturns tend to be sharper than expansions during periods of economic booms. In addition, there is evidence of political cycles, with stronger wage bill growth in pre-election periods. Finally, the analysis reveals that while the size of the wage bill does not seem to systematically affect fiscal discipline across countries, expansions within countries over time are associated with deteriorating fiscal positions. These findings provide a strong impetus for public wage and employment policies that aim to restrain excessive growth of the wage bill during boom periods. This prospective management of the wage bill would not only reduce the need for painful adjustments during periods of fiscal consolidation, but also contribute to strengthening the overall countercyclical and stabilizing impact of fiscal policies.