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Jad Chaaban, Associate Professor of Economics at the American University of Beirut, President of the Lebanese Economic Association, and LCPS research fellow

August 2013
Public Sector Wages Must be Adjusted to Save the Middle Class

During the recent launch of the World Bank report on Lebanon’s economic performance, some participants argued that the proposed salary adjustment, if implemented, would have dire consequences on the Lebanese economy. They went on to state that salary changes would increase inflation due to higher taxes, raise the cost of finance to the private sector through higher interest rates, and entrench inefficiency in the public sector because of the non-merit nature of the adjustment. These allegations are at best misleading: For one, an increase in taxes will not raise the cost of living if the right tax is imposed; the interest rates on private sector loans will not necessarily increase since interest rate determination in Lebanon is not subjected to market dynamics as often claimed; and linking wage increase to public sector reform, although highly desired, will not happen because of the sectarian nature of the state. Before tackling each of these issues, let us look at the context.
Following several strikes and demonstrations early in 2013 by civil servants and teachers in both public and private schools, the Lebanese Government approved in March 2013 (prior to its dissolution) a salary scale adjustment for public sector employees. The new public sector wage scale, along with a suggested revenue package to finance its costs, were passed on to Parliament where they are supposed to being scrutinized. The Union Coordination Committee, the body representing the interests of the 230,000 civil servants and public teachers which is 16% of the labor force, argues that the increase is necessary to compensate for the loss in purchasing power of salaries since 1997. The Lebanese Government has only increased public sector salaries twice since 1997: In 2008 there was a lump-sum adjustment of LL200,000, and in 2012 a new wage-hike decree increased salaries between LL175,000 and LL300,000. These increases were deemed insufficient by civil servants and their representatives, as inflation exceeded 100% since 1997. This meant that nominal salaries and pensions lost a sizeable chunk of their value over this period. In fact, the share of wages in GDP has declined to a mere 22%, down from almost 60% in the seventies.
Opponents of the wage increase, which include several ministers, private sector representatives and also international development agencies, argue that the substantial cost of the wage adjustment (estimated at an average annual additional expenditure of $1.3 billion, or 3% of GDP) would have dire consequences on the economy. For them, if adopted, the new salary scale would increase expenditures, and since public debt is already too high, it must be financed through new or increased taxes. This would raise the cost of living (price inflation) and cause further recession in the economy. They go on to argue that any wage increase must be preceded by a revision of tasks and an improvement in efficiency in order to also deal with a bloated and inefficient public sector.
In fact, there are several fallacies in the opponents’ arguments. First, increasing taxes does not automatically lead to higher inflation, as this depends on the type of taxes imposed on one hand, and on the ability of the production sector to transfer the tax burden over to the consumer on the other. For instance, adding the revenue stamp value to the telephone invoice (which is one form of indirect taxes being proposed) directly affects telecommunications cost. However,  the tax on real estate profits, a direct tax, will not automatically increase the prices of offices or apartments because the real estate speculator, as an investor, cannot increase the price of real estate properties to compensate for the tax impact, as these prices are subject to supply and demand. Note that taxes on profits are very low in Lebanon compared to GDP (less than 2%), given that tax evasion is widespread at all levels. Therefore, the Lebanese economy can bear the burden of additional direct taxes, especially those imposed on high profits from real estate income gains and other types of rentier income.
Second, several opponents of the wage increase warn that interest rates on Treasury Bills must be raised to fund the deficit, which is attributed to higher wage expenditure, which will eventually lead to higher cost of lending for the private sector. This argument is simply not true. The Treasury Bills in Lebanon are not subject to the classic laws of supply and demand, given the close ties between the private local banking sector (that takes up the majority of the Public Debt) and the Government (be it the Central Bank or the Ministry of Finance). The argument regarding the impact on the cost of lending to the private sector may be acceptable in a country with an efficient financial market, as interest rates in banks tend to follow interest rates on treasury bills. However, Lebanon has inefficient markets, and banks do not play a real role in lending to the productive sectors at low interest rates and with facilitating terms. Local banks are very pleased with their fixed income from the Government’s Treasury Bills, and therefore they do not engage in serious competition to lower their cost of lending to the private sector.
Third, the argument that efficiency and productivity should be the real motive behind any wage increase is not in tune with the current dynamics of the Lebanese economy. While it is imperative to rationalize the public sector and increase its productivity, it is widely accepted that in Lebanon, any serious reform is simply impossible given the sectarian nature of the Lebanese State and the deep divisions characterizing the local political scene. Denying civil servants their right to a decent living, including the restoration of the purchasing power of their salaries and pensions, runs the risk of destroying one of the last pillars of what is left of a Lebanese middle class. This will have serious implications of polarization in the country, and would ultimately depress local consumption, which is still one of the main drivers of the Lebanese economy.
In the absence of any serious plan to restructure the public sector and the economy at large, salary scale adjustment must be implemented to preserve the shrinking purchasing power of the middle class. Otherwise, we will be holding people captive to political and economic reforms that are nowhere within sight. More crudely, we will be making the middle class pay for the economic system that benefits only a small segment of the population.

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