1

Analysis of the Recent Downsizing Effort in Sri Lanka[(]

This case study describes a recently announced but not implemented, across-government downsizing exercise in Government of Sri Lanka (GoSL), which was supported by the Bank’s PRSC I. Government offered a Voluntary Retirement Scheme (VRS) to employees 50 and older. They could retire, receiving full salary until age of retirement, and pension thereafter. The case draws parallels between the present effort and an earlier unsuccessful effort at downsizing supported by the World Bank’s 1990 Economic Restructuring Credit.

1.  Why did the Government opt for large-scale retrenchment?

GoSL opted for downsizing its public sector as a response to a fiscal crisis arising, in part, from rapid growth of public sector employment. This action was taken after attrition, recruitment freeze and similar less-painful strategies were ineffective in controlling the wage bill.

Sri Lanka’s public sector dominates the economy, with 3.6 civil servants for every 100 of its population in 2001 The public sector comprises (i) Federal Public Service, (ii) Provincial Public Services, and (iii) Treasury-funded agencies. The employees are broadly divided into four categories based on range of pay scales and responsibilities. Group A comprises officers including those of All Island Services, Group B comprises staff officers or executives, Group C comprises clerical support staff, and Group D represents blue collar workers. Employees in Groups C and D groups constitute 88% of public sector employment.

During 1990-2001, public sector employment grew rapidly: Table 1 below shows an average annual rate of 3.5%. This rate of growth was nearly three times the rate of population growth during the same period. Between 1998 and 2002, central employment growth (23.5%) was nearly double the growth of GDP (12.2%). An earlier retrenchment, funded by the Bank’s Economic Restructuring Credit of 1990, had been counter-productive: the number of employees and ministries increased immediately following the downsizing.

Table 1. Growth in Public Sector Employment in Sri Lanka
Sector / 1990 / 2001 / Increase / Total increase as % of base year / Average Annual Growth Rate (%)
Federal Public Service / 198,425 / 303.331 / 104,906 / 52.9 / 3.93
Provincial Public Service / 222,584 / 286,461 / 63,877 / 28.7 / 2.32
Treasury-funded Statutory Boards and Corporations / 60,000 / 118.000 / 58000 / 96.7 / 6.34
Total / 481,009 / 707.792 / 226,783 / 47.1 / 3.57

Source: Report of Salaries Commission, 2001

GoSL experienced fiscal crunch during the very late 1990s and during the early years of the new millennium, when the annual budgets’ deficit financing were between 7 to 12% of GDP. The 8.1% (of GDP) fiscal deficit of the 2003 budget was unsustainable. The Fiscal Responsibility Act, 2001 targeted steady lowering of the budget deficit, and bringing it to under 5% in 2006. The Act also mandated that GoSL contains it current expenditure to 3% of GDP, and achieves this via reductions in wage and interest expenditure. The weight of the wage and pension bill has crowded out priority expenditure in education, health and essential infrastructure, and even operational expenditure necessary to enable employees’ effective functioning. If current trends continue, by year 2010, government revenue will be completely absorbed by wages and pensions.

Actions less drastic than retrenchment failed to control steady growth in public employment. A hiring freeze had long been in effect, and was extended to hiring of casual workers[1]. To slow down new recruitment, GoSL abolished all vacant posts in 2000: 4700 vacant posts were abolished in the All Islands Service, as were 3200 excess positions of Sinhala teachers i.e., teachers who teach in Sinhala medium. The finance ministry’s budget department limited budget provision in the salaries head to 2002 levels, thus discouraging the creation of any new posts. Yet, as shown in Figure 1, a growth spurt in public employment occurred during 2002 and 2003.

Administrative crises accompanied the fiscal crisis. Overstaffing, administrative fragmentation, low productivity in public sector and politicization of recruitment have ailed the public sector since the 1980s. These were highlighted in several reports submitted to GoSL—including the Administrative Reform Commission’s 1987 report; the 2001 ‘Regaining Sri Lanka’ report by the Treasury Department, and the Cabinet Memorandum of 2004. While implementing reactive responses to an out-of-control wage bill, GoSL made no proactive attempt at reforming recruitment and human resource management, nor in the control of political micromanagement. In 2002, the Treasury advised all departments to undertake functional reviews with a view to task-consolidation and identifying redundancies. But this was not followed seriously by any department. Only the Central Bank initiated functional review, and subsequently designed and implemented a Voluntary Retirement Scheme (VRS).

2.  Was there adequate planning for the downsizing effort?

In 2004, GoSL announced salary and pension increases to all employees, with the biggest increments benefiting lower and middle level employees. Very soon thereafter the Treasury announced a Voluntary Retirement Scheme (VRS), which targeted the reduction of employees 50 or older.

The present VRS’s design did not draw upon the lessons of the previous Bank-supported VRS. The Bank’s Project Completion Report (included in the course pack) cited the earlier exercise as an example of how retrenchment programs can go wrong. Yet, elements of the previous design that had contributed to its lack of success were repeated in the current exercise.

As in 1991, the VRS was unlinked to any broader reforms of the central and provincial governments and rationalization of their functions. The severance payments were equally overgenerous. As before, the new VRS built no safeguards against adverse selection. Earlier many skilled staff had left while the deadwood stayed on. The vacuum created by the departure of experienced staff and skilled personnel, including specialist doctors, had had to be filled by hiring consultants, many of whom who had taken the early retirement package. As pointed out in the Bank’s Project Completion Report, the problem had not been one of wrong diagnosis, but that of faulty design, implementation and monitoring of the scheme, while ignoring the need for eliminating obsolete functions. Paradoxically, Sri Lanka’s own 1987 report Administrative Reforms Commission had warned against piecemeal implementation of the program and the likelihood of chaotic results.

The VRS had neither a strategic objective, nor demonstrated any fit with Cabinet Memorandum’s broader agenda for public service reform. Was the fundamental objective one of financial savings or improved performance? Did GoSL want to reduce the number of ministries, or the number of cadres, or in staff in selected cadres? Was the VRS meant to get rid of inefficient staff, or bring in new skills? It was not enough to merely relieve 300,000 employees from service without the purpose of the exercise or what the following steps would be.

The VRS had been hastily devised and suffered from legal lacunae. Government’s own top legal officer, the Attorney General (AG), was not consulted before the announcement. The Treasury’s circular did not include a negative list of who could not opt for VRS, nor any other enabling exclusion clause that would prevent adverse selection. This would result in loss of critical staff skills (e.g. specialist doctors, paramedical staff, subject matter teachers, and experienced managers). The use of arbitrary criterion like ‘first come first served’ instead of a legally acceptable criterion for priority such as applicants’ seniority in service was likely to be challenged in court.

The VRS’s design was constrained by limited diagnostic and analytic work. Only after Treasury had issued the VRS circular, did GoSL recognize that the Establishment Code needed amendment[2]. Although the Bank’s concern about administrative reform and its dialog with GoSL had resulted in the planning and initiation of analytical work funded by the Bank’s TA, only one of those proposed studies (on establishment control) was undertaken because of lack of initiative from Administrative Reforms Committee.

Inadequate advance planning prevented steps that could have complemented the VRS, and reduced downstream costs. These included:

·  Control over abuse and extent of overtime payments,[3]

·  Use of available provisions to remove undisciplined or poorly performing staff,

·  Compulsory termination of casual and contract workers instead of leaving the door open for their regularization;

·  Exit of staff serving beyond retirement age by scrutiny of personnel records:

·  Census of the civil service and payroll audit to eliminate ghost workers; and

·  Building implementation capacity of Treasury, Ministry of Personnel Administration and key departments

The government could have (but did not) studied the successful VRS of the Central Bank that reduced staff strength by more than half, while excluding senior management and skilled staff. The scheme withstood legal challenges and realized tangible benefits. The success was followed in the Port Authority, using similar methods.

3.  How was resistance addressed?

Government addressed resistance from employees’ unions mainly by avoiding compulsory measures and holding out generous severance packages far superior to those offered earlier to downsized state owned enterprises.

There was apathy to this VRS from within government itself. Only the Treasury owned the VRS; no other ministry had any incentive to collaborate with the Treasury to effectively implement the scheme. GoSL overlooked the administrative capacity needed to manage the process, and the likely legal obstacles. The Treasury circular demanded a huge effort from each ministry to identify the redundant cadres and posts, and to manage the receipt and processing of applications along with attendant legal challenges from powerful staff associations. The ministries themselves had little professional support for the exercise and were further not sure of political support from individual ministers.

Although lack of consultation within government had harmed the previous VRS, the present one did exactly that. It was designed by the Treasury and a small group of ministers without prior consultation and subsequent involvement of line ministries. Line ministries, including the Ministry for Public Administration responsible for HRM, and Provincial Councils were not involved in the drafting of the VRS. At a meeting convened by the Chairman of the Administrative Reform Committee (who was also Secretary to the Prime Minister), senior line ministry officials expressed misgivings about the circular -- including its risk of adverse selection and aggravation of skill shortages. Communicating the rationale of downsizing to a wider group of line ministries could have obtained support from individual ministers. Failure to consult the Attorney General ahead of the scheme’s announcement left GoSL unaware that Constitutional provisions required it to introduce the scheme in provincial councils in the name of national policy.

There was no IEC strategy to support the VRS. The media projected the VRS package as a pre-election bonanza rather than as an element of downsizing. The public was cynical about the exercise because government expanded simultaneously with the VRS offer, and patronage-based recruitment continued. Four ministries were established for regional development though the Constitution devolved this responsibility to the Provincial Councils.

4.  How was staff reduction targeted?

By January 2002, the size of public employment—excluding the army and SOEs—was 736,000 of which about 90% were in groups C and D, as charted in Figure 2 below. The largest groups were the teachers (180,000), police (54000), and health staff (22000).

Figure 2. Public Employment in Sri Lanka

The VRS was inconsistent in who was being targeted to leave. Although the objective was to reduce staff strength in lower and middle levels, Treasury’s circular announcing the scheme was open-ended on numbers and categories of staff.

Instead of advance preparatory work on different what-if scenarios and the costs thereof, these figures were expected to emerge from the work of VRS Committees after the scheme had been announced. Such committees would be set up for each Ministry or a group of small Ministries as well as each provincial Council. The committee would be headed by the most senior permanent secretary and comprised heads of departments and technical secretariats. The committees would decide whose VRS application would be accepted. The process would be overseen by the High Powered Steering Committee in the Treasury.

The VRS’s target was to reduce the workforce of 736,000 by 100,000 by 2004, and by a further 200,000 by 2006. There would be additional, indirect savings in housing loans and employee welfare payments. It was expected that the number of VRS acceptors would retroactively fit the targeted reduction number. The Treasury assumed that all employees eligible for VRS would apply by the prescribed date, but made no provision in the budget for making VRS pay-outs to those who applied for the scheme. The wage bill was estimated to diminish by 28.7%, still leaving GoSL with 3.76 public employees per hundred population, which was 29% above the 1990 level.

5.  How did the VRS package balance between attractiveness to employees and cost-effectiveness for GoSL?

The cost of the VRS package rose on account of

i.  Government’s announcement, ahead of the Salaries Commission’s report, of an across-the board increase of 10% (the increment was higher for agitating health workers) or Rs.1250, whichever was higher[4]. This raised the estimated front-end payment from Rs. 8 billion to Rs. 11 billion.

ii.  Previously awarded allowances (interim allowance of Rs.1200 in 2000, and salary interim allowance of Rs.1000 in 2001) being incorporated into each scale’s base salary, thus increasing the pensionable salary for VRS optees.

iii.  Forgiving repayment of employees’ loans would cost roughly Rs.7.2 billion from 2004 to 2007[5].

The conservative estimate of the VRS payments’ net present value was Rs.28.4 billion ($296 m) during 2004-2007 or Rs.94635 ($986) per retrenched worker. Instead of being offered to all employees, if VRS were restricted only to target Groups C and D, salary savings would be around Rs. 6 billion per year for 100,000 employees or a net present value of Rs.47.5 billion through 2007. If many group A and B employees are allowed to exit via VRS, the estimated costs would rise to $1272 per worker.

Although the per employee payout appears modest compared with VRS costs elsewhere[6], the difference is that GoSL will not save any amount on account of reduction of wage expenditure. Those opting for VRS would continue to receive fully salary. Elsewhere, VRS acceptors have been terminated, and receive retirement benefits instead of salary.