Monitoring and Evaluation of Labor Programs
ASSESSING ECONOMIC RETURNS
This section outlines the rationale for, and elements of, economic analysis of labor programs. The resources listed at the end of this module include several examples of economic analyses of work force restructuring in public enterprises.
Rationale
As discussed above, the near-term financial benefit for government is sometimes the critical factor for cash-strapped ministries of finance faced with an urgent need for infrastructure enterprise reform. However, economic analysis is also needed for the following purposes:
- First, it assesses impact on aggregate output or welfare. Financial analysis tells nothing about whether displaced workers are, in the aggregate, more or less productive following the labor program. It is quite possible that a proposed labor program can be attractive from the financial analysis perspective, but can fail when subjected to economic analysis.
- Second, it provides an answer to opponents of work force restructuring in PPI, who may argue that by ignoring the wider economic costs and benefits, government is making a bad decision (see, for example, the South African case presented in box 6.7 of module 6).
- Third, it may be a requirement of international funding agencies whose lending or funding procedures need economic as well as financial analysis.
Economic analysis provides a perspective that financial analysis alone cannot.
Labor productivity issues are central to an economic view of work force restructuring, which sees the process as a reallocation of resources within the economy. From an economic cost-benefit perspective, the cost of restructuring must be met by an increase in worker productivity following displacement. The effect of moving workers out of the PPI enterprise into other parts of the economy can lead to negative outcomes if overall labor productivity falls, neutral outcomes if overall labor productivity is unchanged, or positive outcomes if overall labor productivity rises. Much therefore depends on the assumptions regarding marginal productivity of the worker in the enterprise compared with the marginal productivity of his or her activities following retrenchment.
Economic vs. Financial Costs
Economic cost-benefit analysis is similar in approach to the discounted cash flow approach to financial analysis. As the spreadsheet sample on the accompanying CD-ROM shows, both financial and economic analysis can be combined in the same cost-benefit model. Financial costs and benefits are substituted by economic costs and benefits in the economic cost-benefit analysis.
Differences between economic and financial costs (summarized in table 7.4) are as follows:
- Financial costs of severance (item 1): In economies with no tax distortions or subsidies, and no fiscal budget constraint, the financial costs of severance would not normally be treated as an economic cost. Rather they would be seen as a neutral transfer payment. Most developing countries, however, do have distortions and budget constraints, so severance payments to workers divert public funds from other uses. Except in a few upper-middle-income countries, a conservative approach would be to treat the economic costs of severance as 100 percent of the financial costs.
Table 7.4: Economic vs. Financial Costs and Benefits
| Item |
Cost and benefit items |
Include in
financial analysis? |
Include in
economic analysis? |
|
Costs |
|
|
| 1 |
Financial costs of severance |
Yes |
Yes-adjusted |
| 2 |
Financial costs of early retirement |
Yes |
Yes-adjusted |
| 3 |
Financial costs of redeployment |
Yes |
Yes-adjusted |
| 4 |
Marginal productivity of employees in the SOE |
No |
Yes |
|
Benefits |
|
|
| 5 |
Financial savings on wages |
Yes |
No |
| 6 |
Financial savings on nonwage benefits |
Yes |
No |
| 7 |
Marginal productivity of worker outside the SOE |
No |
Yes |
| 8 |
Marginal productivity value of labor savings |
No |
Yes |
| 9 |
Increase in privatization proceeds from downsizing |
Yes/No |
No |
| 10 |
Increase in privatization proceeds from faster PPI |
Yes/No |
No |
- Financial costs of early retirement (item 2): Similar considerations apply for the costs of early retirement as for severance. In practice, the principal difficulty is likely to be the estimation of the present value of the net financial costs of early retirement.
- Financial costs of redeployment (item 3): If private sector firms are providing redeployment services (training, counseling, outplacement) then the full market price of the training can be taken as the economic resource cost of redeployment. Where governments delegate redeployment to state agencies that are heavily subsidized and operating below capacity, the economic costs are likely to be below financial costs, and an adjustment factor should be applied.
- Marginal productivity of employees in the SOE (item 4): If there is a genuine surplus of workers, their retrenchment will not result in a loss of productivity in the enterprise, and the marginal productivity of employees in the enterprise can be set at zero. This is a reasonable assumption, if the work force restructuring strategy adequately tackles the risk of adverse selection (for example, through close targeting of workers offered severance, through restricting downsizing to cadres with obvious levels of surplus labor, or through a mixed government-investor approach (see table 4.1, module 4).
- Financial savings on wages (item 5): This is likely to be one of the largest sources of savings. Two points are important:
- Given the evidence of rehiring in many downsizing programs, an explicit adjustment factor to take rehiring into account may be appropriate in the financial analysis. If workers are hired elsewhere in government, or by the same enterprise, financial saving will be reduced. For example, employees of the Sri Lanka Transport Board were induced to leave with severance funding, but were being rehired almost simultaneously (Svejnar and Terrell 1991). High numbers of workers rehired following a labor program are an indicator of the failure of the program, both in a financial sense (a waste of public money in financing the costs of the workers' departure) and in an economic sense (a failed attempt to reallocate the workers' labor to more productive use). Some new hiring is occa- sionally needed, however, to bring missing skills to the work force.
- A decision needs to be made on whether to adjust wage savings to take account of enterprise profits. All other things being equal, a wage saving should ultimately return to the budget whether the enterprise is fully or partially subsidized.
- Financial savings on nonwage benefits (item 6): This should take into account savings from reduced expenditure on all allowances, plus projected cost savings arising from the closure or reduction of services provided to employees such as food, medicine, housing, education, and cheap loans.
- Marginal productivity of a worker outside the SOE (item 7): This is the product of (a) the probability of an employee's engagement in a productive activity and (b) the net income produced by this activity. The marginal productivity of the retrenched worker after he or she has left the enterprise therefore depends greatly on his or her circumstances following retrenchment (see "Assessing the Effects on Workers' Welfare" in this module for a list of potential postretrenchment circumstances). Incomes will depend on worker attributes (age, education, and, in some situations, gender); market conditions (overall economic growth rate, labor market supply, and demand); and worker location (capital city, urban, rural). Estimates of workers' marginal productivity should be based on local market information. This should be assumed to be less than current salaries. But what factor should be applied? Evidence suggests that even in industrial economies a permanent earnings reduction of 15-20 percent can be expected among displaced workers, but reductions may be even greater in developing countries with public sector wage premiums (see box 1.3 in module 1). Moreover, many workers go not into formal employment but into informal employment or self-employment, about which there are fewer data. Estimates of marginal productivity-disaggregated by the major classes of workers-can be best sourced from data of actual wage or income levels outside the public sector, gained from labor surveys, national statistics, agricultural economics studies and research, household income surveys, interviews with placement and business support agencies, and (if possible) focused follow-up studies from earlier retrenchment exercises.
- Marginal productivity value of labor savings (item 8): The economic value of the wage savings following downsizing should reflect the opportunity costs of these savings if invested by the enterprise in expanded service areas, improved productivity, or improved quality of service by the enterprise. Assuming the enterprise is budget constrained, then this opportunity cost can be set as 100 percent of the financial cost.
- Increase in privatization proceeds from downsizing (item 9): Global evidence of the increase in privatization proceeds as a result of downsizing is limited. The best study (that of López-de-Silanes 1997) suggests an increase of net privatization prices of 12 percent for every 10 percent reduction in the labor force. However, because investor behavior is difficult to predict, a conservative approach would be to ignore the prospect of improved privatization prices in both economic and financial analysis, or treat it as a factor in a sensitivity analysis.
- Increase in privatization proceeds from faster PPI (item 10): A key rationale for work force restructuring (particularly through voluntary departure and early retirement) is that it helps remove barriers to PPI investment by reducing political and worker opposition to PPI.
In the absence of country-specific estimates, a conservative approach to cost-benefit analysis will probably ignore this time effect on privatization proceeds, not least because there are many potential sources of delay to a transaction in addition to labor issues. Nonetheless, in some circumstances the time effect may be a significant source of benefits.
