MODULE 5 A severance package has a number of elements. Each element may be governed by different legislation, regulations, rules, or agreements. the levels of which are set out in national or state leg- islation and over which there is no discre- tion (without legislative change) Compensation for enterprise-level benefits, which are payments to retrenched workers for benefits to which they are entitled according to the rules for each enterprise or as part of a formal collective bargaining agreement Statutory end-of-service payments, • • assess payment levels, and how to avoid some assess payment levels, and how to avoid common implementation problems. begin early The design of severance packages must factor in the labor program because it is a critical start will in the success of the program. An early There is, provide time to assess all of the options. no “cookbook” recipe or formula for however, determining severance payments. Severance packages typically include some or all of the following components: 73 hen the broad strategy and options for labor restructuring have hen the broad strategy and is to develop the main elements been determined, the next step approaches to restructuring are of the labor program. Specific

MODULE 1. Severance payments 2. Pension payments 3. Retraining and redeployment support 4. Employee share ownership schemes. Severance payments are an important source of temporary income for surplus workers and they need to be designed and put in place early in the restructuring process. Because they are potentially costly for governments, it is important to design them well. This section of the module provides guidance on how to design severance plans, how to SEVERANCE

of a Labor Program of a Labor 5 Key Elements Each of these components is discussed in depth in Each of these components is discussed in the following sections. At the end of each section is a list of the contents of the CD-ROM that accom- sites, a list of pertinent Web panies this Toolkit, and a list of additional relevant materials and sources.

bound to vary among countries and enterprises, depending on local circum- bound to vary among countries typically include four main components: stances. But labor programs W Labor Issues in Infrastructure Reform: A Toolkit

• Ex gratia severance payments over and Statutory Termination Benefits above statutory minimums, which form part of a voluntary departure agreement with Statutory termination benefits vary considerably workers. among countries, as table 5.1 indicates. Benefits typically are based on a formula linked to years of service. Often workers must have completed a min- Statutory Payments imum period of 6 to 12 months of employment to be eligible for these benefits. The International Statutory payments Statutory termination payments are the minimum Labour Organisation’s “Termination of can be an important payments that any terminated worker must receive Employment Digest” is an online resource that part of the overall according to national or state legislation. These severance package. details national legislation and statutory severance payments must be made whether employees leave

MODULE 5 payments and packages worldwide. through voluntary departure, early retirement terms, or compulsory redundancy. The ILO Web site offers access to comparative data on statutory termination benefits: www.ilo.org. The relevant laws and regulations vary among countries, but typically the main elements of statu- tory payments are: Gratuities

• Notice period, or payments in lieu of notice A gratuity is a benefit paid at termination of service to an employee reaching the date of superannuation • Statutory termination benefits or on retirement, resignation, death, or disablement. • Gratuity benefits Some countries have primary legislation setting out • Pension benefits the basis for statutory gratuity payments, in addi- tion to other statutory termination benefits. In other • Earned leave cases enterprise-level rules may set the terms of gra- • Payment of salary or wages in arrears. tuity or supplement the legislation.

Pensions Notice Payments Pension entitlements are a substantial and impor- Statutory National labor legislation often provides for a termination benefits tant element of a worker’s severance package, and notice period prior to redundancy, typically rang- represent the they are covered extensively later in this module. minimum amounts ing from one to three months and sometimes that all retrenched longer. In many cases there is the option to provide workers must receive. salary in lieu of the notice period. This enables managers to ask employees to leave the workplace Earned Leave immediately—an option with the following advan- Some public sector or enterprise terms and condi- tages: tions provide that termination benefits can include • It avoids having retrenched employees payment in lieu of earned (accrued) leave. For working alongside their retained colleagues, example, in Orissa, India, permanent employees which could lead to tension in the work- are awarded “earned” leave at a rate of 15 days place. per year of service. If a worker takes no earned leave during the course 20 years of service, his or • It enables managers to move quickly ahead her earned leave could total 300 days (15 ¥ 20). At with training and development for retained retirement any unused earned leave can be convert- staff. ed to cash, subject to a maximum amount of eight • It reduces the potential for theft, poor serv- months of salary. In Orissa the payment of unused ice, or sabotage by employees being let go. leave at the end of service is a nonstatutory pay-

74 Key Elements of a Labor Program

Table 5.1: Some Examples of Statutory Termination Benefits

Economy Notice period Termination benefit Other features Information source

Cambodia Sliding scale For workers with Workers on fixed-term con- ILO 2000 MODULE 5 from 7 days more than 1 year tracts (rather than indefinite (minimum) to of service: 2 employment) are entitled to 3 months for weeks’ wages per a severance payment as workers with year of service, up agreed in the labor contract, more than to a maximum of but not less than 5 percent 10 years of 6 months’ wages of the total wages paid dur- service ing the length of the contract China 30 days; notice Generally 1 month Trade unions, workers, and ILO 2000 is compulsory a year labor administration must be consulted Estonia (1) 2 months 3 to 4 months of No other liabilities on firms Orazem and salary, depending Vodopivec 1996 on service period Estonia (2) 2 to 8 months of Venesaar 1995 wages Hong Kong, As contract of After 2 years’ For collective dismissals ILO 2000 China employment, service at capped there are no legislative (Special unless fewer rate per year of requirements for notice, Autonomous than 7 days; two-thirds of last consultation, prior Region) a legal mini- salary or authorization from a mum of 1 HK$22,500, which- judicial or administrative month ever is lower body, or any other restric- tions in relation to proposed redundancies India 1 month’s 15 days’ wages Workers with more than ILO 2000 notice per year of service, 5 years of service also for workers with at are entitled to gratuity least 1 year’s payments service Indonesia Termination 1 month per year General requirement to ILO 2000 requires prior up to a maximum avoid redundancy approval by of 5 years wherever possible the labor administration and consul- tation with trade unions Kazakhstan 2 months 3 months of Code of Laws on salary Labor of the Kazakh SSR (as amended to 1994) Democratic 30 days’ Minimum of 30 Legal requirements to ILO 2000 Republic notice days a year establish fair and rational of Korea standards for selection of redundant employees, and to consult with trade unions

(Table continues on the following page.)

75 Labor Issues in Infrastructure Reform: A Toolkit

Table 5.1 (continued)

Economy Notice period Termination benefit Other features Information source

Malaysia 4 to 8 weeks, 4 weeks for 10 Last-in/first-out selection ILO 2000 depending on days for the first has been imposed by length of year, 15 days for courts service 2 to 5 years, and 30 days per year for periods in excess of 5 years Nepal 1 month 30 days per year Last-in/first-out, plus: Labor Act 1992

MODULE 5 of service, plus • Non-Nepali nationals must gratuity and other be retrenched first, even statutory benefits if they have not been employed last •Workers and employees who are absent for a long period as a result of poor health must be retrenched first The Approval to 1 month a year if ILO 2000 Philippines terminate is dismissed as a required result of new technology; 1.5 months if dismissed as a result of enter- prise closure or attempts to reduce losses Singapore As employment None but that ILO 2000 contract, other- determined under wise statutory collective minima of agreements 1–4 weeks Slovenia 6 months 1 month’s salary Firms are responsible for Orazem and (24 months per year of service taking steps to retrain or Vodopivec 1996 prior to 1991) reassign workers Sri Lanka 1 month, but Labor commis- Labor commissioner ILO 2000 must report to sioner determines has absolute discretion commissioner entitlements but to approve applications her guidance on for redundancy criteria given to employers is to pay 2 to 3 months’ salary per year of service or full salary for the remaining period up to retirement, whichever is less, subject to a maximum of 50 months’ salary

76 Key Elements of a Labor Program

Table 5.1 (continued)

Economy Notice period Termination benefit Other features Information source

Taiwan, 1 month 2 months’ salary for MODULE 5 China the first 15 years of service, 1 month of salary for the re- maining years; maximum of 45 months’ salary Uruguay 1 month’s current www.embassy.org/ salary for each year uruguay or fraction worked, up to a maximum of 6 months’ salary República Up to 3 1 month of “normal “Normal” salary for Coil and Rice Bolivariana months, salary” for each severance is defined as 1997 de depending on year of service; this basic salary plus all fixed Venezuela seniority is doubled, how- regular payments and ever, if the employee allowances and any is terminated with- profit-sharing payments, out just cause. In all brought to a monthly addition, the em- basis ployee receives any undistributed, accumulated inter- est in his or her severance indem- nity account. Vietnam 45 days for Generally, one-half ILO 2000 workers with of a month’s salary an indefinite per year of service employment as severance contract allowance, plus 1 months’ salary per year of service as loss of employ- ment allowance ment, but it is defined in the service rules and regu- other benefits that are due them. Those arrears, lations of individual enterprises. The courts there however, can be substantial if financial problems have enforced the eligibility of retrenched employ- have led enterprises to defer payments for some ees for these payments so enterprises have had little months or years. Arrears may comprise: discretion in their payment. • Unpaid salaries • Unpaid salary increases, cost-of-living Arrears of Salary and Benefits adjustments, or scale revisions • Unpaid allowances or allowance increases There is usually no legal or ethical disagreement that displaced workers should receive any salary or • Unpaid pension fund contributions (both

77 Labor Issues in Infrastructure Reform: A Toolkit

Large arrears can employees’ and employers’ contributions). cent), compensation for cessation of pension (14 come as a financial percent), and ex gratia severance (16 percent) surprise to the Arrears can present practical challenges for the (Chang 2002, pp.11–15). In Brazil, federal rail implementing agency that is implementing the privatization of the agency. Dealing with employees who took voluntary departure terms infrastructure sector, among them: them can delay the received an average of about US$8,000 in ex gratia process and present governments and • Identification of the level of arrears: severance and US$10,000 in legal entitlements. In donors alike with Implementing agencies may be unaware of India, too, workers in Orissa who accepted the some tough policy or may underestimate the extent of arrears. government’s voluntary retirement scheme (VRS) decisions. Enterprise managers also might have under- received a significant proportion of benefits from estimated, hidden, or not reported the scale statutory and contractual benefits—particularly of the arrears problem. If large arrears come workers with fewer years of service (figure 5.1). MODULE 5 as a surprise late in the restructuring Statutory termination benefits are usually paid process, there may be a problem in finding from the current resources of the enterprise. funds to meet them at short notice. Employers simply make the payment out of cur- • Additional time delays: Resolving the prob- rent operating expenses when workers reach a lem of how to finance unexpected arrears specified age or leave the enterprise. Generally can take the time and attention of the imple- there is no method of accounting for these liabili- menting agency. Disputes with unions can ties, even though they can represent a substantial easily arise over arrears. Calculating net future commitment of an enterprise’s resources. arrears can also introduce further complexity Consequently, severance programs can represent and delay. For example, one bus company one of the most difficult problems in a PPI transac- allowed its staff to keep a portion of passen- tion, because they are legally enforceable obliga- ger receipts in lieu of wages, and the register tions that can have dramatic cash flow and solven- Moral hazard is a of these “informal” salaries needed to be rec- cy consequences during labor restructuring. concern for those onciled before arrears could be finalized. asked to finance In Latin America, however, some countries require arrears. Arrears are a particular worry for ministries of workers to contribute to an individual account finance and for donors. Rescuing enterprise man- into which some percentage of their salary is paid agers from the problem of arrears may cause on a regular basis. In the event of separation—vol- greater arrears problems in the future because (a) untary or compulsory—workers can withdraw the rescue signals that government has taken a soft monies from these accounts. Any surplus at retire- approach to the budgets of SOEs, and (b) if enter- prise managers believe that the overstaffing prob- lem ultimately will be dealt with through a gener- ous government severance program (at the time of Amount in rupees 120,000 privatization or before), they have little incentive to tackle overstaffing and to make the hard labor 100,000 adjustment decisions that are needed on a day-to- 80,000 day basis. 60,000

Statutory payments, together with contractual ben- 40,000 efits (described below), can represent a substantial 20,000

proportion of the overall payments to workers in 0 both middle- and low-income countries. For exam- 0–15 16–20 21–25 26–31 ple, in the privatization program in Taiwan, China, Years of service the total severance package for a typical middle- VRS amount Gratuity Earned leave ranked employee with 15 years of service is pro- Figure 5.1: End-of-Service Benefits in Orissa, India portioned as follows: statutory payments (70 per- Source: Adam Smith Institute, unpublished data, 2000.

78 Key Elements of a Labor Program ment can be used toward the worker’s pension At separation, workers will usually have to be Enterprise benefits provision. This approach is effectively a severance compensated for these contractual benefits as part are defined by the administrative rules program funded through forced savings by work- of the overall severance package through one of and regulations of ers themselves, and similar in some ways to the two mechanisms: the enterprise. provident funds described in the pensions section MODULE 5 of this module. Brazil has had a program of this 1. Estimation of the value of each benefit for type for more than three decades, where displaced each worker workers can use their individual FGTS (Fundo 2. Conversion of allowances into a single nom- Garantia por Tempo de Servicio) accounts. In the inal salary (as described in the case of 1990s Colombia replaced its severance pay pro- Mexico railways [box 5.1]), which is then gram with fully funded accounts of this type (de adopted as the worker’s deemed salary in a Ferranti and others 2000). severance formula. In Nepal public enterprises set their own rules and regulations for treating such nonsalary benefits as Contractual Benefits medical coverage, housing, loans, and food Many enterprises provide a range of benefits, allowances at termination. These allowances have including medical, transportation, housing, food, varied greatly, and the government found that it had and other allowances. These benefits are often set to engage accountants and consulting firms to under- out in the administrative rules or regulations for take detailed assessments for each enterprise in order each public enterprise or in collective agreements to estimate the costs of labor adjustment for its pub- or labor contracts. The implementing agency will lic enterprises. In Uganda the rules on termination risk industrial unrest and legal challenges on payments vary among enterprises. Some include stan- breach of contract grounds if agreed benefits are dard allowances received with pay as a basis for cal- not provided. Unlike statutory payments, however, culating terminal benefits; others do not include these the implementing agency does, in theory, have the allowances but do provide formulas that compensate option to negotiate these payments. for them (Campbell-White and Bhatia 1998).

Box 5.1: Mexican Railways—The Daily Integrated Salary t the Mexican National Railroad Company • Incentive payment for attendance and punc- (Ferrocarriles Nacionales de México, tuality A FNM), salary for the purposes of the sev- • Incentive payment for productivity erance scheme was identified as the “daily inte- •Incentive payment for training grated salary.” It was calculated by adding the monthly amount of the base salary to the •Tenure bonus amounts of a wide range of enterprise benefits • Performance bonus and dividing by 30 days of the month. Here is a • Support for automobile fuel list of the potential factors in that equation: This formula was used to calculate the salary that • Base salary applied both for workers eligible for an enhanced • Savings fund (monthly equivalent) early retirement plan (with different retirement ages •Christmas bonus (monthly equivalent) for men and women), and for those workers who were not eligible for retirement but offered instead • Payment for vacations a severance plan. Depending on their daily inte- • Special bonus for housing rental grated salary, age, tenure, and gender, workers • Special bonus for transportation received, on average, between US$10,000 and • Payment for basic bundle of goods US$25,000 as a severance payment (based on the average exchange rate in 2000). • Payment for educational support of children Source: López-Calva 2002.

79 Labor Issues in Infrastructure Reform: A Toolkit

Contractual benefits can be complex. The labor or may be provided as a special ex gratia end-of-serv- contract for workers in the Mexican national rail- ice benefit for workers. Either (capped) reimbursable way (Ferrocarriles Nacionales de México [FNM]) costs or, more commonly, a defined allowance is paid contained more than 3,000 clauses. In such cases toward the costs of transportation to a designated renegotiation and simplification of the labor con- home location for the employee and his or her family tract and payment rules are effectively essential and for the transfer of household furniture and pos- prior actions to privatization and may include sim- sessions. The designated home location is often the plification of the rules on compensation for the loss location recorded in the employee’s service record at of benefits for redundant workers. In Mexico a the date of joining the PPI enterprise. These temporary contract was agreed to during the allowances are most relevant where there are tradi- restructuring process for FNM—one that simpli- tions of migration to work or where ethnic group

MODULE 5 fied the contract to 211 clauses. Following the pri- or family links to the home area are important. vate investment in infrastructure (PPI), the new railway operators negotiated separate labor con- tracts (López-Calva 2001). Ex Gratia Severance Payments López-Calva 2001 (a PPIAF case study). Ex gratia severance payments are often provided as part of the overall severance package. Particularly in Housing is often an important benefit that needs Many governments countries where the need to reward or placate labor have chosen to treat separate treatment. Two issues must be addressed housing as a is strong and social safety nets are lacking, as well as in this regard: noncore asset and in countries where labor legislation prohibits out- to sell it. Workers right layoffs, governments have resorted to promot- may have first • The immediate treatment of displaced refusal or receive workers living in enterprise-provided hous- ing voluntary departures by offering severance pay- discounted prices. ing: The usual arrangement is to allow ments that exceed legally mandated requirements. workers to continue to live in the housing for a specified period after termination, sometimes with reduced rents. For example, Developing Severance Formulas Tanzania Telecommunications Corporation Ltd. allowed workers a six-month rent-free Worldwide, in both private firms and in govern- period in which to find alternative accom- ment, the most common approach for defining sev- modations. Brazil’s railway, RFFSA, allowed erance payments is a formula based on a multiple separated workers to stay in their housing of years of service and salary. Such formulas are for one year. easy for managers to use and are widespread in both the public and private sectors. Table 5.2 • The disposal of housing that is no longer describes some advantages and disadvantages of needed: Options include sale of the houses, the standard formula. with employees possibly offered the right of first refusal or a discount on the market sale The formula for severance payments has varied price; transfer of houses to local or munici- widely among countries and, within countries, pal governments (a practice that has been among enterprises in different sectors, depending common in transition economies); and on legal and contractual obligations and the transfer of houses to a government property strength of labor unions. Examples of formulas agency that continues to collect rent and used and the resulting payments in a range of manages the disposal of the government’s infrastructure enterprises in developing countries Ex gratia payments property portfolio in a structured way are presented in table 5.3. are at the core of designed to maximize revenues. lump-sum Additional data tables summarizing the key features severance Allowances for travel to home may be part of the of public sector and state enterprise severance pro- packages. normal statutory, enterprise, or contractual benefits grams worldwide.

80 Key Elements of a Labor Program

Table 5.2: Advantages and Disadvantages of Standard Severance Formulas

Advantages Disadvantages

• Relatively simple to understand, communicate, • Can be imported easily. Managers in a hurry may MODULE 5 and implement sometimes simply copy formulas from another • Attractive to unions because they can negotiate country or enterprise. a formula for a class of workers • Can substitute for analysis of actual needs • Attractive to government because it can set a single formula as part of a uniform approach

Table 5.3: Examples of Severance Formulas and Payments

Economy/ Key features of Source for enterprise voluntary departure Other features further details Argentina: Post-PPI voluntary retirement under- Workers who left under Shaikh 1996 Buenos Aires taken by the concessionaire voluntary retirement received Water and approximately US$10,000 Sewerage in severance Argentina Severance package is approximately In 1992 workers received Shaikh 1996 Electricity 10 percent greater than the statutory approximately US$10,000 termination package in severance. Argentina Rail 1 month per year of service, Approximate cost in 1990 of Ramamurti with no cap US$10,000 per worker 1997 Bolivia Rail 3 monthly wages plus an equivalent The amount offered was the Valdez of 1 wage per year of work for those same as statutory payments; 2002 with more than 5 years of service, Bolivian capitalization program plus statutory unemployment benefits had made a policy decision to implement a uniform scheme for all enterprises; no incentive for workers who voluntarily retired Brazil: Workers with 4 to 10 years of service, Those who left voluntarily Carneiro São Paulo 1 month’s salary per year of service; gained a cash bonus of 33 and Gill Railway workers with 10 to 20 years of service, percent of monthly salary 1997 2 months’ salary; and workers with up per year of service; average to 25 years of service, 2.5 months’ total package received per salaries; workers also receive 180 per- worker was estimated cent of the accumulated funds in their at R$29,870 FGTS accounts (a compulsory employee severance indemnity fund, to which all employees in Brazil contribute 8 percent of their basic salaries each month) Brazil: Rio Grande 60 percent of a month’s salary per Average package per worker Carneiro do Sul State year of service, but capped at 15 was R$41,900 and Gill Electricity months’ salary; additional incentive 1997 Company for workers near retirement age is (Table continues on the following page.)

81 Labor Issues in Infrastructure Reform: A Toolkit

Table 5.3 (continued) Economy/ Key features of Source for enterprise voluntary departure Other features further details

10 percent of all remaining wages up to the date of retirement; workers also receive 140 percent of the funds in their FGTS accounts Brazil: 50 percent of a month’s salary per year Carneiro São Paulo of service for those with less than 10 and Gill Electricity years’ service; 40 percent if more than 1997 Company 10 years of service; no cap; workers also receive 140 percent of the funds MODULE 5 in their FGTS accounts Brazil 4 to 12 months of salary, depending Only workers with more than Estache, Federal on years of service, increasing for 6 years of service were eligible; Schmitt Railway workers with 6 to 25 years of service workers were allowed to keep de Azevedo, and decreasing for older workers with their use of housing for up to and more than 25 years of service; workers 12 months and pension pay- Syden- who delayed accepting voluntary ments were continued for stricker departure and were made redundant 12 months; average payment 2000 during the period 1 year after privatiza- to workers was about tion received 80 percent of these US$8,000, plus US$18,000 benefits of statutory benefits

Guyana Severance package equivalent to 22 Hinds 1995 Telephone months of salary and Telegraph Company India: 1.5 months of salary per year of Three times better than Kouamé Federal service, or 15 days’ salary for each statutory termination benefits 1997 VRS year until retirement at age 58, of 15 days’ salary per year Scheme whichever is less, plus statutory of service (1993–95) benefits India: 1.5 months’ salary for each year Ray 2001 Orissa State of service, or 30 days’ salary for each Electricity year until normal retirement date, Board whichever is less, plus statutory benefits Mexico 4 months of salary plus 30 days for Salary was a daily integrated López-Calva Federal each year of service; part-time salary, which included base 2001 Railway workers receive 3 months of salary salary plus 12 other allowance (FNM) plus 20 days of salary for each year elements; workers typically of service received between US$10,000 and US$25,000 in severance. An enhanced pension package was also provided, funded in part from privatization proceeds. Pakistan: Based on plan for industrial plant Evidence of adverse selection Kot Addu privatization in Pakistan; voluntary (the most productive Power departure package of 4 months’ workers leaving). Average Plant basic salary per year of service, costs in 1990–93 were plus gratuity of 1 month’s basic about US$3,000, but costs

82 Key Elements of a Labor Program

Table 5.3 (continued) Economy/ Key features of Source for enterprise voluntary departure Other features further details

salary per year of service (the “4+1” at some industrial plants Kouamé MODULE 5 rule); officer cadre staff had a less- rose to US$10,000 1997 generous package of 2 months’ after 1993 salary per year of service plus gratuity (the “2+1 rule”) The Severance package based on years Typical package for Cruz 2001 Philippines: of service, using an “adjusted worker with 20 years Manila monthly pay” to take into account of service totaled about Waterworks various allowances (this was US$15,400, roughly twice and around 30 percent higher than basic the standard government Sewerage pay); workers with less than 20 package of termination System years’ service receive 1.5 months benefits per year of service; those with 20 to 30 years of service receive 2 months’ salary; and those with more than 30 years of service receive 2.5 months of salary. Taiwan, Severance payment of 6 months Applicable to all employees Chang 2002 China of salary in addition to statutory retrenched at privatization (Privatization payments. or laid off within 5 years Law) after privatization Vietnam Severance pay of 1 month per year Workers can obtain 6 Government (Decree of service (minimum 2 months); months’ training at of Vietnam 41/2002 on additional compensation of 1 month vocational training centers; 2002 policy for per year of service; lump sum of workers who are 5 years redundant VND 5 million; continued salary for short of the pension age workers 6 months searching for job. have the right to continue in SOEs) paying 15 percent of salary to social insurance in order to qualify for pension and death gratuity benefits

In some cases an established uniform formula may precedents, even if those precedents are in different already be in place, in which case the key decisions sectors and under different circumstances. already will have been made. Where the formula is Spreadsheet tool for analysis of severance options. not considered sufficient or where there is no for- mula in place, a new formula may have to be In setting a level of severance for voluntary depar- developed. ture programs, the attractiveness of the package to workers has to be balanced with its affordability At the absolute lower limit, workers must receive for the government. If the payment is too low, the statutory minimum set out in the law. In prac- workers may not volunteer to leave, and that can tice, however, earlier precedents might set a de threaten or delay the overall objective—a success- facto floor for negotiations. The absolute upper fully completed PPI transaction. Low levels of sev- limit would be to place a worker on permanent erance are sometimes combined with a degree of administrative leave with full salary. Although that coercion (for example, threats of compulsory practice is uncommon, more often the practical redundancy, unit closure, or wage arrears). Such upper limit is again that set by previously agreed coercion will engender adversarial relationships

83 Labor Issues in Infrastructure Reform: A Toolkit

Overpayment is with workers, unions, and government, and can • Ability to transfer costs to the taxpayer: common in publicly damage the political credibility of PPI. If the pay- Governments can agree to generous terms financed severance schemes. ment is too high—that is, more than workers (which makes difficult negotiations with would actually need as sufficient compensation for unions easier) and then transfer the cost of the loss of employment—the government may not that generosity to future taxpayers, as in Sri be able to pay it, and it may lead to excessive num- Lanka (Salih 2000). bers of workers leaving the enterprise, including • Use of precedents: Where other organiza- the best workers. tions have made generous payments (for any In practice, developing severance formulas is more of the reasons outlined above), plan design- likely to produce overpayment than underpayment ers are likely to make the same mistake, either by meeting previous precedents or

MODULE 5 for several reasons: simply copying the earlier formula in the • Political impact: Except in the face of seri- name of uniformity. ous financial crisis, relatively generous sever- Where generous and unaffordable precedents have ance payments are politically attractive. been set, choices must be made between using • High levels of compensation: Salaries and those precedents or negotiating new severance for- benefits are often higher in the public sector mulas. The choice will depend on the degree of than in the private sector (for example, see political support for implementation, the costs Bales and Rama 2002, Bhorat and Liou imposed by the precedents, and the degree of con- 2002, Panizza 1999, and box 1.1 in module cern for provision of a social safety net for dis- 1 of this volume).Where program designers placed workers. A cost-benefit analysis of the recognize a public sector wage premium financial and economic effects of the various they can reason that relatively generous sev- options (see module 7) can inform this decision. erance awards are necessary if workers are to leave voluntarily. In designing severance levels there are various ways to achieve a balance between attractiveness and • Bias by plan designers in favor of generous affordability, and those ways are discussed next. packages: This bias can occur for two rea- sons. First, designers may become too close Setting Minimum and Maximum Levels to the concerns of workers or to the con- A minimum severance level, or a floor, can be set cerns of enterprise managers (for example, at some point above the statutory minimum termi- how to make downsizing go as smoothly as nation benefit. A floor can be a useful tool for possible), and align themselves—perhaps demonstrating that the severance package is fair unconsciously—with those interests rather and benefits everyone, including lower-paid staff. than the interests of either public finance managers or society as a whole. Second, by A maximum severance payment, or a cap, also can erring on the side of generosity, plan design- be set. One of the main potential criticisms of sev- ers can help ensure that the program is a erance plans, especially generous ones, is that high- “success”—an example of self-serving bias est-paid workers or managers can obtain excep- in their decisionmaking. tionally high payments. A cap is a simple measure to prevent such criticism, and can be expressed in •Availability of donor funds: Although recur- absolute money terms or in months of pay. For rent expenditures, including salaries, may be example, the government of Madhya Pradesh tightly controlled (subject to a hard budget VRS-98 placed a monetary cap of Rs. (rupees) constraint), donor funds for enterprise 500,000 on payments to workers. restructuring may be readily available. That combination of circumstances can encour- Establishing Preretirement Rules age overpayment. On its own, a simple straight-line formula (salary ¥

84 Key Elements of a Labor Program years of service) would give maximum payments to ics and econometric methods, has been pilot-tested Loss-based the oldest workers in each cadre of employees. Just by the World Bank in Guinea-Bissau, Madagascar, formulas have a more rational basis before retirement they would have the maximum and Tanzania, and has been described by Chong and address the payment. This is clearly a potential source of influ- and Rama (2000). This approach (which is dis- major weaknesses ence in employees’ behavior: it encourages employ- cussed in greater detail in module 7) recognizes of empirical “rule- MODULE 5 of-thumb” ees to stay on so that they receive higher compen- that workers’ total incomes often will fall following approaches. sation amounts, and it discourages earlier volun- separation or retrenchment (box 5.3), and it tary departure. Some empirical formulas attempt to attempts to assess the level of severance that should offset this by including an element that reduces be paid to offset those earnings losses. The follow- payments as the retirement age approaches (see, for ing bullet points summarize the key features of this example, box 5.2). approach:

Another approach to the preretirement period is to Chong and Rama (2000) described the application of make workers who are past a specified age and a loss-based approach in Guinea-Bissau. within a few years of normal retirement ineligible for voluntary departure. This can improve efficien- • Although the output from this approach to cy because workers approaching retirement clearly designing a severance package is a formula, have the least expectation of loss. If, however, there it is one that takes account of the factors is a sharp cutoff, again distortionary effects can that influence individuals’ likelihood of gain- arise. For example, if a plan is introduced in which ing income after severance. For example, if workers with fewer than five years until retirement better-educated workers are more likely to are ineligible for voluntary departure, there will be return to higher-paid employment after sep- a very high uptake of the option to leave by work- aration, the formula will reduce their sever- ers approaching cutoff point as well as a degree of ance payment. If women workers are more dissatisfaction and inequity for workers who for likely to have difficulty in finding a job, the timing reasons just miss the newly introduced ben- formula will increase their severance pay- efits. ment. • The formula uses objective data, such as Adopting Loss-Based Formulas national household survey data, surveys of An alternative approach to the standard way of living standards, or labor force surveys, to setting severance amounts, based on labor econom- generate an econometric earnings function for private sector workers. By comparing incomes and benefits of similar workers in Box 5.2: Brazil—Reducing Payments for the formal (or informal) labor market, esti- Older Workers mates of the likely earnings losses can be n Brazil’s federal railway privatization, workers made. with 6 years of service received 4 months of • The losses recognized include earnings lost Isalary, and for every additional year of service that amount was increased by a factor of while a worker searches for another job; 1.0595 for each of the 19 increments up to 25 permanent loss of earnings that arises years of service. Workers with 25 years of serv- because a worker transfers to the private ice therefore received 12 months of salary as an sector (remember, many public sector work- ex gratia voluntary departure payment. For ers earn a premium wage); estimated losses workers with 25 to 30 years of service, pay- ments decreased by a factor of 0.8705, so that of tangible benefits (for example, trans- a worker with 30 years of service received 6 portation to work, food and housing subsi- months of salary as voluntary departure pay- dies, and medical benefits); and estimated ment. losses of intangible benefits (for example, Source: Estache, Schmitt de Azevedo, and Sydenstricker job security, flexible working times, oppor- 2000.

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Box 5.3: Earnings Losses after Retrenchment here are no tracer studies of the long-term severance, although workers who found wage impact of retrenchment on workers in employment had a much smaller reduction in T developing countries. In industrial coun- income. Note, however, that although: tries, however, the evidence is that earnings loss- under current economic conditions, many es have been both large and persistent. Reviews retrenched workers can expect their lifetime by Fallick (1996) and Kletzer (1998) on displaced earning stream to be appreciably lower.... we workers in North America indicate persistent are persuaded that the difference in earnings earnings losses of between 10 and 25 percent of before and after redeployment reflects the predisplacement earnings up to 10 years after loss of a rent associated with civil service displacement. employment.... What the employees have lost, In Turkey earnings after reemployment among then, is a privileged post that, one can argue, MODULE 5 petrochemical and cement workers displaced they should not have held in the first place. during privatization were 57 percent and 61 per- Their gain in getting a civil service job was the cent, respectively, of their earnings prior to layoff. Ghanaian taxpayer’s loss, and vice-versa for Most workers also lost a range of nonwage ben- the post-redeployment loss in earnings efits (Tansel 1996). (Alderman, Canagarajah, and Younger 1996, In Ghana follow-up assessments of the earnings p. 285). of civil servants showed a 48 percent fall after

tunity for bribes, access to equipment, and program. A delay in implementation while a facilities for private use). new approach and formula are being devel- oped and negotiated could also wipe out Table 5.4 summarizes the advantages and disad- any potential cost savings from adopting vantages of loss-based formulas. They can deliver this approach. the fairest levels of severance payment for individu- als. Furthermore, by careful targeting they can • Data requirements are substantial and the reduce the costs of the severance program for gov- process can be time consuming if enterprise ernment and avoid adverse selection. Estimates of personnel records are poor or if there is little the level of costs savings realized from tailored for- information on nonwage benefits or on the mula compared with savings realized from an likely postseverance livelihoods and incomes empirical formula are 31 percent for SOEs in of workers. Egypt (Assaad 1999) and around 20 percent in the Like other severance formulas, loss-based formulas case of the Central Bank of Ecuador (Rama and will need to be understood by unions and workers MacIssac 1996, 1999). and be discussed during the consultation process:

But there also can be some difficulties in adopting If appropriate compensation is needed to make a loss-based approach: the workers accept the prospect of downsizing, • Loss-based formulas are likely to be less rel- it is very likely that the package will have to be evant where there are existing and well- negotiated with the public sector trade unions. established precedents for severance formu- In that case the final compensation package las. Any change is likely to require substan- may not be the cheapest one, or the fairest one, tial effort and to involve negotiations with but rather a compromise shaped by the bar- unions, approval by ministers, and parlia- gaining power of all the players involved. From mentary debate. this perspective the [loss-based approach] should not be seen as an example of “mindless • Delays incurred as a result of designing and social engineering,” but rather as a tool to negotiating complex severance formulas introduce some economic rationality into deli- might threaten the pace of the overall PPI cate political negotiations. While the approach

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Table 5.4: Advantages and Disadvantages of Loss-Based Formulas

Advantages over empirical formulas Disadvantages over empirical formulas

•Tailors the package to compensate individual • Is subject to legislation or existing labor con- MODULE 5 employees so that the compensation that each tracts that may preclude different (discriminative) employee receives is more fair—those who treatment of workers according to factors such stand to lose most will receive the most as age, gender, ethnicity, and location • Reduces the risk of overpayment, which has • Potentially adds time to the work force restruc- plagued severance programs worldwide turing process because of the need to locate specialist skills, conduct econometric analyses, and persuade policymakers and unions • Has not yet been implemented beyond pilot (proposed) plans • Has a formula whose derivation is difficult to explain to policymakers and unions when seek- ing their support

could certainly be refined, it represents an prise or to adopt a uniform severance plan for all improvement compared to the ad hoc way in public enterprises is a critical preliminary decision. which these negotiations are usually carried out Table 5.5 presents the advantages and disadvan- (Chong and Rama 2000, p. 26). tages of each approach.

Whatever approach is selected, severance payments A case-by-case approach to severance, where pay- in early retirement, voluntary departure, and com- ments are negotiated at the enterprise level, has pulsory redundancy schemes can be structured to arisen when there is a cautious, incremental provide time-based incentives for workers to leave approach to PPI and when, in the absence of any early. overall labor policy or guidelines, labor restructur- ing is dealt with at the transaction level. In some More generous packages for voluntary departure cases enterprises are also governed by their own than for compulsory redundancy are the norm. labor rules or labor contracts, thus leading to a During Brazil’s railway reforms, workers were case-by-case approach. In others, a case-by-case clearly informed that any compulsory retirees approach has been adopted to ensure flexibility would receive only 80 percent of the package given based on the individual circumstances of the com- to those who took voluntarily departure benefits pany. Some governments, for example, have treat- (Estache, Schmitt de Azevedo, and Sydenstricker ed profitable and unprofitable enterprises different- 2000). In Turkey the privatization law offered 30 ly, allowing profitable ones to pay higher levels of percent more to employees who volunteered for severance out of their own resources. That was the early retirement (Tansel 1996). Early applicant case in India and also in Tanzania when the gov- bonuses can be offered. In the 1992 British ernment opted to concession port services and con- Telecommunications downsizing plan, early appli- tainer terminal operation (box 5.4). cants received an incentive payment. Although a case-by-case approach can provide Estache, Schmitt de Azevedo, and Sydenstricker 2000 flexibility, it can also create unwanted precedents. Each new award raises the minimum severance level for the next negotiations, and there is a Choosing a Uniform or a Case-by-Case ratchet effect that ensures increasing levels of sev- Approach erance. Such approaches can also fuel distrust in For government the decision whether to negotiate the process and bring the wider PPI program into severance on a case-by-case basis for each enter- disrepute, thereby threatening its sustainability

87 Labor Issues in Infrastructure Reform: A Toolkit

Table 5.5: Advantages and Disadvantages of Uniform and Case-by-Case Approaches to Severance

Approach Advantages Disadvantages

Uniform •Treats all workers more equally • Needs good analysis of long-term downstream • Has a more transparent process costs to avoid danger of government initially setting • Reduces information asymmetry too-generous limits overall (especially if the first between government and programs are small PPI transactions with low num- unions—both know what the bers of affected workers) deal is • Prohibits introduction of loss-based formulas tai- • Has predictable costs for lored to each enterprise severance in future years

MODULE 5 • Facilitates central (ministry of finance) oversight and control over public spending on severance Case-by- •Gives most discretion to • Signals to workers and unions that the level of sev- case government in setting severance erance is—in principle—always negotiable payments in each enterprise • Encourages bidding up of severance payments (a • Allows the tailoring of payments ratchet effect) and sets a precedent for other PPI to each work force and—in transactions theory—the potential to deliver • Favors workers in enterprises with the most power- the lowest-cost programs for ful unions, the most influential leaders, or the great- government (in practice, that est potential to inflict economic damage through occurs only if government is strikes or industrial action politically very strong) • Is less transparent •Leads to unpredictable costs for work force restructuring •Provides an opportunity for confrontational negotia- tion on both sides •Is only effective if there is a strong government that is robust in the face of vested interests and case- by-case lobbying •Makes monitoring and control of commitments more difficult if deal making is delegated to enter- prise managers

(see box 5.5). Moreover, trade unions often Uniform guidelines can be perceived to provide fair oppose differentiation between enterprises on the and equal treatment for all workers and help grounds that (a) there should be equality of treat- ensure some measure of predictability in the ment for all workers in SOEs and (b) the financial process. distress of loss-making enterprises can be attrib- uted to government mismanagement and there- fore it is unfair to penalize employees. Adverse Selection and Targeting Given the potential problems of a case-by-case A major issue in many severance programs is how approach, there are advantages to adopting uni- to avoid adverse selection and rehiring of the best form severance guidelines that, with some measure workers. Better targeting and selection of workers of flexibility to take into account enterprise circum- help avoid these problems. stances, are applied to all enterprises (table 5.5).

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Box 5.4: Tanzania—Severance Policies in Port Concessioning n 1996 the government of Tanzania decided to (because the remaining THA operations were invite private sector participation in the delivery also listed for PPI). of port services in Tanzania. They also invited 2. The workers in the other utilities and infrastruc- I MODULE 5 private sector participation in the container termi- ture industries would use the case of the con- nal operation of the Tanzania Harbours Authority tainer terminal as a precedent. They would (THA) in the form of a 10-year operating lease. argue that the source of funding was unimpor- THA was one of the few SOEs in Tanzania with a tant and that the issue was one of equity. history of sustained profits, and these profits 3. There was a question of selection. The new resulted from its monopoly position and because operator (Tanzania Industrial Container Terminal fees to shipping companies were set in U.S. dol- Services Ltd. [TICTS]) was allowed to select lars. THA as a whole employed 3,500 workers; of from the 500 employees those whose services that number 500 were directly associated with it wished to retain. The question arose whether the container terminal business. to pay only those who were not selected for During the privatization of the container terminal reemployment or to retrench all 500 container the problem of how to handle severance came to terminal workers. Again, the workers and the fore. Earlier proposals by the World Bank had unions would take the decision as a precedent. suggested that government declare a consistent The government decided that all 500 container ter- policy on severance. Government had decided, minal workers would be retrenched and paid the however, to retain its existing policy, which pro- statutory dues and that those workers who were vided that: not reemployed would benefit also from the ex gra- •Where an SOE was taking a loss, was unable tia payment. Those employees who declined reem- to fund severance costs from profits, and had ployment lost their rights to the ex gratia pay- to rely on the central government budget to ment—a policy intended to avoid the problem of make severance payments, only the statutory employees with critical skills declining employment, minimum severance obligations were to be benefiting from the ex gratia, and later being met by government. rehired by TICTS because their skills were critical. •Where the SOE was able to fund severance The ex gratia payments amounted to about 12 payments from profits, it could be permitted to months’ pay in addition to statutory payments. pay an ex gratia sum beyond the statutory The outcome is that the government has minimum. resolved labor issues in the PPI transaction of the In pursuing a program for severance of surplus container terminal. It also has avoided potential staff, THA decided to offer an ex gratia payment industrial unrest among other THA workers (who in addition to statutory minimum obligations. were watching and now expect similar treat- Three problems immediately surfaced: ment). However, the wider problem of inconsis- 1. Although the number of workers involved and tency in the treatment of some 21,000 workers in the financial cost were small in absolute other utilities and infrastructure remains. terms, whatever was agreed would set a Source: Parastatal Sector Reform Commission, Tanzania; precedent for the other 3,000 THA workers Adam Smith Institute.

Adverse Selection When an ex gratia severance payment is offered equally to all workers, it is usually selected by the In many severance schemes there are concerns most skilled and most capable employees. Those about adverse selection: that is, there is concern employees, who can easily find alternative employ- that the program will lead to the departure of the ment elsewhere in the economy and who believe best workers and thereby result in the loss of criti- they have a bright future outside the enterprise, are cal skills and in the subsequent rehiring of workers precisely the people that the restructured enterprise who have received public money for severance. would most want to retain. Overpayment of sever- This section of the module provides some guide- ance in public enterprises further contributes to lines for addressing these concerns and making sev- adverse selection. In Argentina, for example, early erance more efficient. railway retirees were among the most productive

89 Labor Issues in Infrastructure Reform: A Toolkit

Adverse selection is Enterprise managers are concerned about the Box 5.5: Problems with Case-by-Case a common challenge potential problem of losing their best people and in work force Setting of Severance—Sri Lanka and their knowledge, particularly during periods of restructuring. Zambia transition to new management and new working Sri Lanka: Upward Revisions of Ad Hoc methods. For PPI investors, however, the transi- Severance Payments tional challenges of taking over management are Average ex gratia severance payments in Sri more acute because it is vital to avoid disruptions Lanka’s privatization program rose from 17.5 months of salary in 1987 to 53 months in 1997. in essential infrastructure services and to keep By the time that Lanka Lohan (a steel company) operations and equipment going until new equip- was privatized in 1997, the package was con- ment and systems have been set up. sidered so attractive that all workers applied to

MODULE 5 leave the firm, a clear sign that the package was overcompensating them. The increases took place because of strengthening trade union bar- Approaches to Selection and Targeting gaining power, and the “ad hoc and lackadaisi- cal manner in which labor issues were handled” Mechanisms to better target severance payments (p. 190). In Sri Lanka, severance packages cus- are the principal solution to the problem of adverse tomized on a case-by-case basis for each selection. If there is an across-the-board offer with enterprise proved to be downwardly rigid and no targeting or selection, anyone who volunteers confusing to the parties involved and they encouraged rent-seeking behavior and hostility for severance is automatically able to receive it, to privatization. Another outcome was that gov- although perhaps on a first-come/first-served basis ernment was no longer able to easily afford to and perhaps with a cap on the number of workers restructure labor before privatization. who can take the offer. This approach is most like- Source: Salih 2000. ly to lead to adverse selection. Zambia: Disparity in End-of-Service Benefits Fuels a Distrust of Privatization Better selection or targeting can be achieved in a The United Bus Company of Zambia was insol- number of ways, whether undertaken before PPI vent and was forced into liquidation. Under the by government or after PPI by the new investor. applicable bankruptcy law, employees were Table 5.6 summarizes the advantages and disad- entitled to 200 kwacha (equivalent to US$0.30) vantages of alternative approaches to selection. as preferred creditors for the legal minimum (Note, however, that in some cases, the implement- end-of-service benefit; for any additional amount they ranked as ordinary creditors in ing agency or the investor may have little choice of accordance with their contract terms of employ- selection tools if these are mandated in a collective ment. In contrast, a cleaning worker who left bargaining agreement.) Zambia Telecommunications after working there for only two years reportedly received a pay- Establishing selection procedures is therefore a crit- ment of 2 million kwacha (US$3,000). Such ical management task in any labor program. egregious disparities between the legal and Attention to detail and a commitment to enforce contractual minimums for end-of-service bene- selection are essential. The following sections elab- fits can create opposition to privatization and delay transactions. orate on the main tools for better selection and tar- Source: World Bank 1996e; quoted in Campbell-White and geting: active management selection, management Bhatia 1998. veto, and selection by cadre.

Active Management Selection employees, whereas many unproductive workers The data sets and tools used for staff audits (see stayed, which led to production problems and module 3) can help managers in the active selection shutdowns on various lines. In Pakistan, overly of staff and cadres for retrenchment. Those tools generous severance plans reportedly encouraged include: the most productive workers to leave.

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Table 5.6: Advantages and Disadvantages of Alternative Selection Approaches Personnel records are a first source of data, but human Selection resources approach Advantages Disadvantages departments often

lack skilled MODULE 5 professionals and No targeting • Has simple rules—either available • Has maximum risk of adverse selection adequate record- (volunteers) to all or on a first-come/first- • Effectively uses no selection tool at all keeping. served basis until all available funds are committed •Suits circumstances with weak PPI enterprise managers Last-in/ • Has simple rules—either available • Has significant risk of adverse selection first-out to all or on a first-come/first- • Is a crude mechanism for selection selection served basis until all available funds are committed • Can be used to substitute for management decisionmaking in circumstances with weak PPI enterprise managers or weak human resources and appraisal systems • Can be perceived as fair • Is sometimes mandated in legislation Active Has a lowered risk of adverse • Is demanding of managers (although staff and skills management selection audits can provide some independent assess- selection ments) •Needs to be handled in a transparent manner to avoid accusations of bias •Is the slowest process, needs reasonable person- nel records Management Has a lowered risk of adverse • Is demanding of managers (although staff and skills veto selection audits can provide some independent assessments) •Can easily lead to accusations of unfair treatment from the best workers •Needs to be handled in a transparent manner to avoid accusations of bias Selection Can deliver a relatively low risk • Uses a relatively crude selection tool by cadre, of adverse selection, depending • Does not identify the best or worst workers within a location, or on the structure of the work cadre or location operating force and the quality of the • Is open to abuse (e.g., by prior transfers of unit staff audit individuals)

• Staff and skills audits, which help identify tests (that is, tests of the ability to do specific Selection will be a critical skill sets that must be retained or are tasks), or on a special skill audit contentious issue, so a fair process is in short supply • Education and qualifications records, which essential. • Individual appraisal or assessment records, can lead to poor selection when used alone based on the normal performance appraisal because they neglect the questions of tacit review on internal competency assessments knowledge and institutional memory

91 Labor Issues in Infrastructure Reform: A Toolkit

• Training records, and evidence of employee have not raised the expectation that the response to training departure package is available automatically to all workers. Consider this approach, for • Assessment based on the comments of example: supervisors and managers, including assess- ments of employees’ willingness and flexibil- Deselection of certain potential [voluntary ity to undertake a range of work, as well as departure] applicants was done by per- their job histories (which offer evidence of sonally calling those employees and per- increasing levels of responsibility) and their suading them not to apply since their possession of transferable skills future in the company was bright (Ray 2001). • Attendance records, which detail unautho-

MODULE 5 rized leave and medical absences (whether Ray 2001 (a PPIAF case study). uncertified, self-certified, or certified by a doctor) • All parties have reasonable expectations that prospects in the company will improve after • Special interviews and tests specifically for PPI (this will depend in part on the sector). selection prior to severance can supplement other data or fill in the gaps where an •Managers are prepared with plans for future employee’s records are poor or missing if salary structure and performance-based they are undertaken in an objective manner incentives to encourage workers to stay. and if they probe and test for relevant skills Selection by Cadre and competencies. Selection can be imposed through eligibility restric- The primary problem in management selection is tions, which only allow certain groups of workers that many worker traits are unobservable. Put sim- to participate in a voluntary departure plan. The ply, it is hard for the designer of a severance pro- criteria for selection may be related to age, years of gram to design selection criteria that distinguish service, cadre, grade, operating unit, or location: between the productive and the unproductive • Age or years of service eligibility criteria: worker on the basis of written records alone. Some severance packages are only open to Reliance on only one test may be unwise, as was workers with a minimum period of years of found in Guinea and Sri Lanka (see box 5.6). service. This will discourage younger work- Using a range of the above tools is wise, and can ers from taking voluntary departure, and is help assure workers and unions that the process is rational where a shift in the age or experi- being carried out in a fair and transparent manner. ence mix is an explicit objective. A problem Selection tools will be most effective where an can arise where mandated last-in/first-out effective appraisal system is already in place, rules combine with minimum eligibility rules together with competent and professional human to selectively disadvantage newer workers. resources management. The approach also may not be appropriate if large numbers of workers have recently been Veto by Management taken onto the permanent rolls (for example, Giving managers the right to reject applications on as a result of negotiations with trade unions an individual basis is another option. In practice to regularize temporary workers). this is a difficult route for many managers because • Cadre: If there is overstaffing in particular they have to be prepared to reject applications for cadres, tiers, or grades, the plan may be voluntary departure from their best workers. The offered only to those groups. task is made easier if: • Operating unit or location: Voluntary depar- • Relationships between managers and staff ture may be offered only to workers in par- are sound, and program communications ticular units (for example, a construction or

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Eligibility is another Box 5.6: Challenges of Selection—Guinea and Sri Lanka mechanism for Guinea: Selection of Water Utility Workers in Sri Lanka: Worker Selection Processes during selection and Conakry Privatization targeting. The process of workers to transfer to new water “It was difficult to screen the high-quality workers MODULE 5 companies was conducted through a series of from the low-quality workers. Even where exams objective tests (initially managed by the World were held for this purpose, those workers who Bank) that were “supplemented” with recommen- wanted to leave the firm [through a voluntary dations from former managers at the former utili- departure scheme] performed in the exam very ty—the DEG. The subjective evaluations raised poorly” (Salih 2000, p. 193.) serious concerns about objectivity (Ménard and Clarke 2000).

maintenance unit) or in an operating divi- • The time period for restrictions: Are work- sion that is particularly overstaffed or that is ers barred forever or just for a certain peri- being closed or outsourced. od (one year, five years)? As with other selection tools, selection through eli- • The scope of the restriction: In the public gibility criteria requires commitment from govern- sector, drawing reasonable reemployment ment, as was found to be true in Sri Lanka (see boundaries can be difficult because of the box 5.7). intricacies of government. For example, if an employee is laid off from a state-owned The alternative selection approaches discussed above and outlined in table 5.6 are not mutually exclusive and can be used in a mix. To illustrate, there could be no selection for unskilled cadres who are all surplus workers or for all workers in a Box 5.7: Sri Lanka—Experiences of regional unit to be closed, but active selection by Selection through Eligibility Criteria management of all other cadres. “ ven when tiers of surplus labour were identified before putting VRS into opera- Etion, some workers maintained that this was discriminatory and that the option of volun- Prohibition on Rehiring tary retirement should be extended to all work- ers. However, the main opposition to targeting The revolving-door syndrome (where workers are tiers for retrenchment came from workers who rehired after receiving severance) is indicative of a were not targeted. Opposition came from the more skilled grades of workers who felt they poorly managed labor program. Many severance could obtain windfall gains through the compen- schemes therefore set out explicit rules prohibiting sation packages, since they could find alterna- rehiring. These are worth having, given the poten- tive jobs without much difficulty. Hence, identify- tial political and financial cost of such rehiring. ing tiers of redundancy labour for voluntary Enforcement is difficult, however, and such restric- retirement was eventually dropped and across- tions usually can only reduce, not eliminate, the the-board voluntary retirement was applied. This is why the problem of adverse selection (better risk of rehiring previously separated workers. workers leaving) was common in Sri Lanka’s voluntary retirement process.... Even where Before they receive their severance benefits employ- workers of an identified tier were subject to ees are usually required to sign a commitment not VRS, the problem of adverse selection could not to return to work in the same enterprise. The be altogether avoided because the better work- design of any restrictions on rehiring will vary ers within the tier opted to leave” (Salih 2000, p. among countries and circumstances, but all should 193). address the following aspects:

93 Labor Issues in Infrastructure Reform: A Toolkit

Governments can telecommunications company, can he or she cedures, (2) payment options and procedures, and ask workers to sign work again for that same company or its (3) monitoring and evaluation arrangements. This a no-return agreement prior to legal successors (post-PPI)? For other public section covers the first two items; the third item is receiving severance, enterprises? For other local, state, or federal discussed in module 7. but it can be difficult government bodies? For subcontractors to enforce restrictions on engaged by the PPI enterprise following pri- rehiring within vatization? Severance Procedures government. • Penalties to workers for breaking the terms Well-documented redundancy and severance proce- and conditions: These may be strengthened dures can improve the quality and transparency of by including obligations to repay severance severance and can avoid the potential for dispute monies or lose the tax privileges associated MODULE 5 and opposition during implementation, which in with severance if workers are subsequently turn may create delays. The advantages of having found to be rehired. clearly established procedures are that (a) there is a • Mechanisms of enforcement and legislation: common understanding on the terms, conditions, These can present practical difficulties in and definitions applicable to severance; (b) the monitoring and enforcement, and legal chal- prospect of redundancy has been raised and dis- lenges in countries where the labor law does cussed (in some PPI utilities, the culture may still be not permit restrictions on recruitment. one of “jobs for life”); and (c) there are clear • Restrictions on the use of funds: Some guidelines for conducting severance activities (such donors have rules that restrict the use of as calculation of amounts owed to each worker or their funds. For example, World Bank loans disbursement procedures). cannot be used to finance the severance of Severance procedures should be set out in a policy workers who leave and subsequently are statement or in regulations at the government or rehired either in another part of government enterprise level, and usually are agreed to by gov- or in the same company after privatization. ernment and worker representatives before restruc- (See the discussion of financing arrange- turing starts. The CD-ROM accompanying this ments in module 1.) Toolkit provides an outline of a general redundan- • The views of PPI investors: These views cy policy and an example of a redundancy policy should be sought wherever possible. Some from a privatized freight railway. plans mandate that workers cannot work Outline of a redundancy policy. again for the same enterprises, but do not restrict workers from working for the new privatized company. This was the case in Redundancy policy for a privatized railway. Brazil’s railway privatization (Estache, In addition to establishing procedures, govern- Schmitt de Azevedo, and Sydenstricker ments can develop a manual for the entire sever- 2000). Elsewhere, however, investors have ance process. The typical content of such a manual suffered from voluntary departure schemes is set out in box 5.9. that have prohibited workers from being Enterprise benefits employed by the subsequent PPI company. Severance procedures generally cover the following can be complex and (See the example of Chile’s railway, Fepasa, areas: time consuming. in box 5.8.) Detailed manuals may be needed to • Eligibility criteria: Sometimes legislation or define exactly how labor contracts will only provide for full- enterprise-level Implementation Issues time or permanent employees as eligible for benefits will be severance. The implementing agency will treated during Three main implementation issues arise in sever- need to ensure that the treatment of other severance. ance programs: (1) the definition of severance pro-

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Box 5.8: Chile Rail—Severance Benefits and Rehiring Rules hen a PPI investor, Unirail LLC, paid the state in effect paying twice for the same US$31 million to buy a 51 percent employee. stake in Fepasa, a privatized rail line in 2. Employees of EFE who did not meet the W MODULE 5 Chile that the government was putting up for requirements for the above benefit (and there- sale, difficulties arose almost immediately. The fore were not subject to the rehiring restric- existing public railway employees had little incen- tions) would receive a reduced benefit equal to tive to stay with the new company because the 50 percent of their monthly salary for a period government was offering them generous pen- of months equal to half the number of years of sions to retire immediately. Almost all of them service plus one. Therefore, a person with 23 did. Soon the new owners were left with virtually years of service would receive 50 percent of no skilled staff. “This was a really difficult thing salary for 13 months. The great majority of for us at all levels,” recalls Larry McCaffrey, presi- EFE’s employees did not have 25 years of dent of Unirail. “Why they did it, we don’t know” service and thus this benefit applied to most of (Moline 2000, p. 4). the 2,200 available employees, from which In 1991 the Chilean Parliament adopted a law Fepasa needed about 400. offering severance terms to workers who had left Neither of these benefits applied to the senior EFE, the state railroad. There were two main cir- people who were paid more than $1,800 per cumstances: month and who were free to choose what they 1. Employees separated from EFE having 25 wanted. years of employment, of which at least 10 The principal problem for the PPI investor was were with EFE, received a salary each month that the primary people it wished to hire were the equal to 1/30th of their monthly salary for each older drivers and electricians with more than 25 year of service, up to a maximum of 30 years, years of service because of their experience and which is the point of retirement. Thus, a worker their work ethic. Those people, however, did not with 25 years’ experience would receive 25/30 accept the work because they had a significant of his last month’s salary for the following 5 financial incentive to stay away. This greatly hurt years, and then he would receive his normal Fepasa at the time of start-up of operations retirement pension. A condition of the above because the most valuable workers were not benefit, however, was that the employee could available to the concessionaire. not work for EFE or for concessionaires of EFE Source: Moline 2000; Unirail LLC, personal (such as Fepasa) during the period of the ben- communication. efit. The intention of this policy was to avoid

categories of workers is properly defined, 5.10, for example). In practice, given the including: often very low wages of this group, the incremental cost to government of includ- – Temporary, daily paid, seasonal, intermit- ing temporary workers within a severance tent, or part-time workers: Unions will program may be small relative to the ben- often want to make casual workers per- efits of doing so. Such calculations will manent as part of the preprivatization have to be done on a case-by-case basis. restructuring and thus make them eligible for severance, as was the case in India’s – Probationary staff, apprentices, and con- telephone and power sectors (see box 4.8 tracted workers are often excluded from and box 5.10). If, however, it is clear severance plans. The rights of these from staff audits that there are large groups depend much on national or state amounts of surplus workers in these cate- legislation, which can affect the design of gories, it may be preferable to make spe- the severance package. cial severance provisions to compensate – Officers and managers: Senior staff workers for their losses, provide a social (defined by grade or by salary) may be safety net, and secure support (see box

95 Labor Issues in Infrastructure Reform: A Toolkit

Box 5.9: Content of a Severance Manual hat should be included in a severance finance or by a committee involving represen- manual? Circumstances will differ but tation from the ministry of finance. The stan- W the procedures could include the fol- dard format aims to ensure that all costs are lowing material: captured, including statutory payments, enter- • Full definitions of all key terms. prise dues, ex gratia severance payments, arrears of salary, arrears of pension contribu- • A description of the timetable for labor adjust- tions, other allowances, and other costs arising ment. This will include descriptions of any from the restructuring. If a noncore activity is enterprise restructuring activities (for example, being sold, closed, or liquidated, there will be closure of operating units, depots, or work- other costs to the ministry of finance, such as shops), levels and scope of downsizing, phas- those associated with salaries of core staff ing, and timetable. MODULE 5 (security and accounting staff often need to be • A standard format or spreadsheet for calculat- retained), as well as valuation, privatization, or ing the amounts due for every worker. This will liquidation costs. be based on an agreed formula. • A standard letter of agreement between the PPI • Detailed definitions of the calculation of sever- enterprise manager and the government. This ance benefits—statutory and contractual. This will outline the role of the PPI enterprise man- will supplement the paper format or spread- ager, as well as public finance arrangements. sheet because calculating the value of the • A standard letter that all workers sign when contractual (enterprise) benefits and accepting voluntary departure. This will include allowances, in particular, can be challenging. their acceptance of any restrictions on rehiring, There may be different schedules and eligibility and verify their recognition of any tax or social rules for different groups of workers. And if insurance consequences. those benefits are not well defined, if enter- prise human resources management has been • Terms of reference for the engagement of weak, or if data are missing, then in practice accountants and auditors to help implement a the interpretation of the rules may have been program. and continue to be subject to considerable • A standard format for the disbursement of pay- discretion. One unit manager may apply rules ments to workers. This format should provide differently than another, and similar workers for the signatures of the workers to acknowl- can receive different severance amounts. edge receipt, as well as countersignatures by • A standard submission format to the decision witnesses (such as independent accountants body for release of funds. Normally, approval or auditors). for the release and transfer of funds for sever- • Standard formats for tax purposes as appropri- ance will require review by the ministry of ate for the national tax regime.

excluded from a severance package, grated salary” made up of 14 different given their higher salary and benefits lev- elements was used both for severance pay els. For example, in the concessioning of and for early retirement packages. Chile rail, senior staff earning over – In Chile retirement benefits are calculated US$1,800 a month were not eligible for on the basis of a “worker’s reference early retirement benefits (see box 5.8). salary,” which is calculated as the annu- • Definition of salary: alized salary over the last five years of employment. – Many if not most plans define basic salary as the base for calculating sever- • Definition of years of service: In practice this ance payments. needs to take account of issues such as: –A combined salary and benefits definition –Will prior service in another organization is another approach. In the case of be taken into account? Mexico rail (box 5.1), the “daily inte-

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– How are part-years calculated? • Taxation: Treatment of severance pay varies among countries, with many countries treat- –Will service as a temporary worker ing severance pay as tax free, and some count? (such as Malawi) treating it as a taxable

–Will service as an unregularized tempo- benefit. MODULE 5 rary worker count? – What about apprenticeship or probation- Payment Options and Procedures ary periods and interruptions to service (such as times of military service)? The implementing agency must decide how to pay • Constraints on reemployment. severance to workers. Early retirement benefits are normally paid from the pension plan. For sever- • Treatment of other benefits (loans, medical ance, the main options are to: insurance, and so forth). • Provide severance in a single payment. • Treatment of housing occupied by the Many governments favor this approach workers. because (a) employees tend to prefer lump- sum payments, (b) it is administratively sim- pler, (c) it provides a clean break, and (d) it avoids an impression of continuing govern- Box 5.10: Regularizing Casual and ment obligations toward the displaced Stipendiary Workers in the Orissa Power worker. There are risks that a proportion of Sector workers can very quickly dispose of lump- ublic sector enterprises can engage large sum payments on consumption. Clearly, numbers of workers on ad hoc or occa- some cultural specifics in certain countries Psional terms. In the Orissa State Electricity may predispose those workers more toward Board, for example, 5,336 semiskilled workers, consumption than in other countries—for engaged for extended periods as daily paid example, because of the social status of cost- “nominal muster roll” workers, were regularized ly weddings or funerals. as part of the preprivatization restructuring of OSEB. Their remuneration then rose from Rs. 30 • Provide severance as a salary continuation. per day to about Rs, 3,500 per month. Similarly In Chile’s rail sector most workers received some 250 so-called stipendiary engineers had been employed by OSEB through emergency 50 percent of their salary for a period equal recruitment procedures, but they lacked any to half the number of years of service plus service benefits other than a fixed stipend. one (see box 5.10). In a 1,000-response sur- Following corporatization of OSEB, most of vey of severance practices in the United these engineers were regularized and made per- States, where severance is typically one or manent employees of the successor compa- two weeks per year of service, 47 percent of ny—the Grid Corporation of Orissa . organizations implemented severance pay- Although these groups were relatively weak stakeholders, their regularization helped create a ment through continuation of the salary strong positive impression regarding the reform (Lee Hecht Harrison 2001); a similar per- process, and helped to back up the stance centage (46 percent) used lump-sum taken by the government of Orissa that power approaches and some offered workers a sector reforms would not lead to compulsory choice between the two methods. retrenchment. These workers could have been retrenched but, according to one former chair- • Provide severance over a defined period. For man/managing director, “possibly with such a example, when the Uganda Railways beginning we would not have been able to carry Corporation retrenched 1,300 staff in 1997, on with the reforms” (p. 24). severance benefits were paid over a three- Source: Ray 2001. year period (Murungi 2002).

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There are choices • Provide all severance as an annuity. This is the help of the government accounting or for when and how unlikely to be acceptable to workers if they auditing staff: This can help ensure that severance payments are made. have some pension arrangements or if they processes are consistent with national public had the choice between early retirement and finance accountability regulations and with a lump-sum payment. the requirements of any donors involved, defended from potential fraud, and able to • Allow workers to freely choose among a provide an adequate subsequent audit trail. lump-sum amount, staged payments, and an annuity. • Hiring accountants to provide implementa- tion capacity: Accurate calculation and veri- Workers’ preferences for these different options will fication of worker payments can be a time- vary among countries. Preferences can be determined consuming task in large-scale programs. If MODULE 5 through well-designed and statistically valid surveys records are not computerized it might take representing all of the work force (all ages, all cadres, 30 minutes to check each application. If and both genders), perhaps as part of the prelayoff 2,000 workers are to be retrenched, it would worker surveys (described later in this module in the be equivalent to 125 person-days, without section on redeployment programs). Factors that allowing for travel times and delays resulting influence workers’ preferences are likely to include: from missing information, unclear rules, and • Inflation: Workers may want to quickly con- other anomalies. Where internal resources vert a lump sum into a tangible asset, such are limited this task can be contracted out to as housing, and may reject phased payments national firms of accountants or to other if there is a history of high inflation in the professional firms of auditors or consultants. economy. Some guidelines for this process include the following: have a panel of accountants to • Degree of uncertainty about the future, both draw from, emphasize the need for inde- personal and economywide. pendence of the accountants, do not let • Potential for small business: If workers (or, enterprises select their own accountants, and perhaps, their spouses) can see income-earn- make the accountants also responsible for ing opportunities, they may favor the oppor- the accuracy of the payment process. tunity to invest lump-sum amounts of their • Developing computerized information tech- severance compensation in establishing a nology systems that enable rapid analysis of new microenterprise or small business. worker dues: In the privatization of Brazil’s Accurate and prompt payments of severance are RFFSA, each RFFSA office was equipped critical. Workers who are paid incorrectly or late with software that gave information on all are treated unfairly and can create public dissatis- the incentives offered to each worker and a faction with the process. Moreover, in the absence simulation of the benefits each would obtain of clear payment procedures there is a risk that sev- (Estache, Schmitt de Azevedo, and erance monies will be captured by fraudulent peo- Sydenstricker 2000). ple or that there is wide disparity in implementa- • Monitoring payments: The scope of work of tion among different units of the enterprise. any subcontracted accountants and auditors Therefore, the job of the manager in the implement- can include supervision of the actual handover ing agency is to ensure that the right worker receives of payments to workers (see module 7). the right amount, at the right time, with no surpris- es. This generally involves the following steps: Tools (on the CD-ROM) • Carrying out pre-audits of the proposed Sample severance spreadsheet funds disbursement system, preferably with Outline of a redundancy policy

98 Key Elements of a Labor Program

Sample redundancy policy (EWS Freight Railway) about the difficulties encountered in downsizing a large public sector.) Terms of reference for a severance consultant

Other Material and Sources MODULE 5 Additional Material (on the Fiszbein, Ariel. 1992. “Labor Retrenchment and CD-ROM) Redundancy Compensation in State-Owned Carneiro, Francisco G., and Indermit S. Gill. 1997. Enterprises: The Case of Sri Lanka.” Internal “Effectiveness and Financial Costing of Voluntary Discussion Paper 121. World Bank, South Asia Separation Programs in Brazil: 1995–1997.” Region. Washington, D.C. Economic Notes 25, World Bank, Country Department, Latin America Region. Washington, ILO (International Labor Organisation). 2000. D.C. Termination of Employment Digest. Geneva: International Labour Office. )For updates, see also Estache, Antonio, Jose Antonio Schmitt de Azevedo, the following area on the ILO website: and Evelyn Sydenstricker. 2000. “Labor www.ib.org/public.english/dialogue/ifpdial/publ/ Redundancy, Retraining, and Outplacement during publ_empt.htm.) Privatization: The Experience of Brazil’s Federal Railway.” Policy Research Working Paper Lee, Barbara. 1991. “Should Employee Participation WPS2460. World Bank, Washington, D.C. Be Part of Privatization?” Research and External Affairs Working Paper 664. World Bank, de Ferranti, David, Guillermo E. Perry, Indermit S. Washington, D.C. Gill, and Francisco H. G. Ferreira. 2000. “Helping Workers Deal with the Risk of Unemployment.” Starcher, George. No date. “Socially Responsible Chapter 6 in Securing Our Future in a Global Enterprise Restructuring. A Joint Working Paper of Economy. Latin American and Caribbean Studies. the International Labour Organisation and the Washington, D.C.: World Bank. (Provides an European Bahá’í Business Forum.” International overview of income support programs that have Labour Office, Geneva. Available at www.ilo.org. been used in Latin America, including severance pay, public works programs, training programs, and unemployment insurance.) PENSIONS AND PPI Gupta, Sanjeev, Christian Schiller, and Henry Ma. This section identifies the key pension challenges fac- 1999. “Privatization, Social Impact, and Social ing the implementing agency and provides a brief Safety Nets.” Working Paper 99/68. International Monetary Fund, Washington, D.C. introduction to pension plans for implementing agencies that may lack pension expertise.

Web Sites International Labour Organisation: www.ilo.org. The Pension Challenge (Several papers on labor issues in the context of pri- Implementing agencies face several challenges relat- vatization and enterprise restructuring.) ed to pensions. First, dealing with the accumulated PSIRU (Public Services International Research Unit): liability of pension benefits that have already been www.psiru.org. (A research unit that receives core promised and earned by current workers often is funding from Public Services International [PSI], the essential to determining whether privatization is global confederation of public service trade unions. feasible. Accumulated pension obligations may It conducts research on public services, privatiza- tion, and globalization, particularly in the water, take a variety of forms, some of which may not be energy, waste management, and healthcare sectors.) readily apparent in the financial records and state- ments of an infrastructure enterprise. Workers in World Bank. “Shrinking Smartly”: potential PPI enterprises quite often are enrolled in www.worldbank.org/research/projects/downsize/. the pension plans of civil servants or participate in (Site is a clearinghouse for researchers, development practitioners, and government officials concerned the so-called provident funds established to provide

99 Labor Issues in Infrastructure Reform: A Toolkit

some mechanism for mandatory retirement savings their accumulated pension benefits is commonly for salaried or formal sector workers. used to provide incentives for voluntary depar- tures or to achieve work force reductions in the In other cases special supplementary arrangements least disruptive or controversial manner. These have been created to provide additional benefits to strategies have significant financial implications workers in industries of strategic significance (such and may have substantial political and social poli- as transportation, defense, and law enforcement), cy consequences so they must be carefully devel- for workers in difficult or dangerous occupations, oped with consideration for their objectives and or for workers in highly skilled or high-pay indus- costs. (Those considerations are discussed later in tries. These benefits may be in the form of supple- this module.) ments to existing public social security programs or

MODULE 5 special-purpose pension arrangements to provide Finally, designing the pension program to meet the benefits to workers in a particular enterprise or future needs of a privatized entity is a key element industry. Both are often operated on a largely of its viability as a going concern. In nearly all cir- unfunded or “pay-as-you-go” (PAYGO) basis in cumstances, including those in even the most fully which obligations are treated as a current operat- developed economies, access to a reliable means of ing expense rather than paid from reserves or asset saving for retirement and providing old-age income pools to which payment is made at the time a security are crucial aspects of attracting and retain- future obligation is incurred. ing high-value added labor. Workers in key man- agement positions or with particularly valuable This generally leads to circumstances in which, on skills may be attracted to PPI candidates solely on an economic if not legal basis, there is a large lia- the basis of the access they provide to reliable pen- bility for future benefits that are not accounted for sion programs. This is especially true in developing and for which funds have not been set aside. When or transition economies in which there are few workers are covered by special-purpose pension competing alternatives available. arrangements, they can be legally enforceable obli- gations. When they participate in public or civil The way in which pension programs are structured servants’ programs—although these may function in anticipation of or following privatization on a PAYGO basis, they are likely to perceive inevitably involves tradeoffs between controlling accrued pensions as implicit obligations that must costs and providing sufficiently generous benefits be settled when an entity is privatized. to recruit and retain an appropriate work force. Available is a range of choices in the design of a Accrued pension liabilities typically are not fully (if pension program that will need to be carefully con- at all) reflected in financial statements. These obli- sidered in the context of the type of workers gations, often referred to as arrears or unfunded required, the consequences of the choices made, the pension liabilities, can be substantial. In industries usefulness of the choices as a labor management with declining labor forces or aging worker popu- tool, and the pattern and level of associated costs. lations, past pension obligations may be the single largest liability when properly measured and may Some types of pensions are very effective in attract- represent a multiple of the market value of an enti- ing younger, educated workers, often those with ty. For these reasons PPI investors may be reluctant highly valued and marketable technical skills. to take over an entity until they are assured that Other types are more effective in retaining older accrued pension obligations are fully resolved. workers or key management staff. Some pension arrangements have lower or more predictable Second, pensions are a central concern as well as costs, whereas others enable sponsors to constrain an effective tool in restructuring a labor force cash outlays in early years but may involve greater through downsizing. Providing early retirement uncertainty about their long-run expense. These programs or establishing arrangements in which choices and tradeoffs are essential to the value and workers can retain or access some of the value of viability of a privatization candidate and are dis-

100 Key Elements of a Labor Program cussed further below. (See also the case of Morocco and may be the single largest tax privilege in many The first challenge is rail presented in box 5.11.) countries. to meet pension obligations that have been promised and Although there is a wide variation in their specific earned by current

design, there are two basic types of pensions. The workers. MODULE 5 Types of Pension Plans older and more traditional pensions are those that Pensions are essentially collective arrangements promise workers a level of income for the rest of designed to provide income for people no longer their lives after they reach a specified retirement able to work because of age. In nontraditional soci- age. These generally establish a benefit level based eties or in industrial economies in which the multi- on a formula that takes into account wages earned The second generational household is no longer the norm, pen- and years of employment covered under the plan. challenge is to use sions provide a means for the elderly population to These are broadly termed defined-benefit plans and pensions as an survive. Pensions can be organized and run by gov- include the majority of the public social security effective tool for labor restructuring ernment and public institutions, by private firms, systems, civil servants’ pension plans, and many through early or by a combination of both. older occupational plans. Some defined-benefit retirement. plans try to set aside sufficient funds to pay the Pensions may be organized as contractual savings benefits by estimating their future value at the time in which a worker builds up assets or credits that they are earned and are therefore called funded are returned in a variety of forms as income fol- plans. Others—commonly public social security lowing retirement or through the redistribution of and civil servants’ plans—pay benefits out of cur- income from active to retired populations. Pensions The third challenge rent receipts and are called unfunded arrange- is to design pension are typically afforded tax privileges under which ments. plans for the post- income taxes on the value of payments or contri- PPI enterprise. butions are deferred until the time they are received Glossary of pension terms as retirement benefits. This “consumption tax” treatment often has significant fiscal consequences

Box 5.11: Morocco Rail—An Unsustainable Pension Scheme n 1996 the government of the Kingdom of tributions plus a variable amount paid by ONCF Morocco approached the World Bank for sup- to match the deficit. The system placed a major Iport for the restructuring of the state-owned burden on ONCF finances. The high cost of the railway, Office National des Chemins de Fer pensions was the result of very generous arrange- (ONCF). A key element of the restructuring was ments. The plan rules set the normal retirement the conversion of the enterprise from a public age at 55 years (50 for drivers, compared with 60 corporation to a joint stock company. Although years in the national retirement fund), and offered the ratio of staff costs to traffic revenue was bet- proportional early retirement after 21 years of ter than that of most European railways at the service, an annual contribution rate of 2.5 percent, time, it was still too high to ensure a sustainable a high reference wage, wage-based indexing, and financial position for ONCF, especially in the face supplementary allowances and reversion of pen- of stiffer road competition. Labor costs were to sion rights for family members. These benefits be brought down to about 30 percent of operat- were unsustainable and would require an annual ing revenues; this would involve a reduction in contribution rate of 50 percent if it were even to personnel from 13,800 in 1995 to 10,000 in 2000. achieve a real financial yield of zero percent. Corporatization would not be possible, however, Measures to change ONCF’s pension system without changing the pension arrangements. The were urgently needed because the downsizing ONCF pension plan was an internal fund, more program, plus a staff age profile leading to steadi- favorable than the common system applied to pri- ly increased retirements (the number or retirees vate enterprises, with pension benefits paid increased by about 200 annually), would make directly by ONCF. Retirees were paid their rights the plan even less tenable. directly from the yearly staff and employer’s con- Source: World Bank 1996d.

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Other pensions essentially provide a savings be covered—typically including infrastruc- account for each individual in which contributions ture workers. from the worker (and often the employer) accumu- National pension schemes are typically late. The value of these contributions and the earn- operated primarily on a PAYGO basis and ings from their investment accumulate in these consequently have large unfunded and quite individual accounts. On reaching a specified age, often untenable levels of future benefits. or sometimes under other conditions such as sepa- These arrangements can range from modest ration from employment, the worker becomes enti- in scope to very generous (from those that tled to the value of the account. In these arrange- seek to replace half of a worker’s income to ments there is no promise of a benefit level; all that those designed to replace nearly all of a is promised is the commitment to maintain the worker’s income, even if that is not feasible MODULE 5 account. The benefit received is directly linked to over the long term). Infrastructure workers, the value of contributions made, so these are gener- especially in strategic or dangerous indus- ally called defined-contribution plans. tries, may be afforded special privileges in The observation is often made that in defined-ben- these plans that provide higher income efit arrangements the sponsor incurs all of the risks replacement rates or retirement at a younger of unanticipated changes in investment returns or age. Compensating workers for the loss of from miscalculations about the amount of time these special privileges can be very compli- workers will live after retirement, whereas in cated and expensive and thus represents one defined-contribution arrangements these risks fall of the more difficult pension problems in primarily on the individual worker. This principle privatization. Public plans facing financing is central when considering any restructuring of shortfalls may also seek payments to cover pensions in the privatization process. these future commitments if they are to be maintained—an expense that can be a Any type of pension can be organized on a nation- major issue in privatization. al basis, by a single enterprise, or by a group of • Civil servants’ pension plans: Many coun- related employers. Pensions can be organized and tries without national schemes or those with administered by public or private institutions or by modest benefit levels have established spe- a combination of both. Workers in infrastructure cial pension programs for civil servants. enterprises may be covered by any of these types of These are often designed to provide nearly pensions operated by either type of institution or full income replacement, often at young through a combination of arrangements. retirement ages, to compensate for the pre- Some of the more prevalent types of pension sumed lower pay levels of civil servants or arrangements are: to retain members within the career civil service. Regardless of whether either of these • National pension plans: Some countries motivations is necessary, the tradition of have established government-run social high pension levels for civil servants is main- security programs that generally cover all tained in many developing countries. They Two basic types of workers in the so-called formal sector— pensions: are nearly always defined-benefit plans, those who are receiving money wages. although this is slowly changing. They may • Defined-benefit Coverage is typically limited to this group be operated in conjunction with a national plans, where the because it is only through wage records that plan or they may move covered workers risk lies with the taxes and contributions can be collected and sponsor into a separate arrangement. • Defined- benefit levels can reliably be set, although in contribution many circumstances this relationship is tenu- Infrastructure workers are often included in plans, where the ous at best. In developing economies only a these arrangements and may perceive them- risk lies with the selves as having forgone a significant por- employee. small fraction of the total population may

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tion of their potential wages or other value of these savings to pay for relatives’ National pension employment opportunities in the expecta- funerals, weddings, or education expenses plans usually are PAYGO. tion of future high pension levels. This may or they are permitted to withdraw funds or may not comport with reality, however, when leaving a job before retirement age.

because with civil servants more broadly the Because they are purely defined-contribution MODULE 5 expectations and perceptions will be key in nature and therefore, by definition, fully issues in any labor restructuring. Civil ser- funded, these types of pension arrangements vants’ plans commonly are operated on an pose fewer problems of past liabilities or unfunded or partially funded basis. future commitment during PPI. They can, in fact, be a type of vehicle that essentially pro- As with national plans, these plans may not vides a source of severance pay to mitigate have aligned required contributions with the the short-term consequences of labor needs of long-term solvency and thus may restructuring. represent an indirect source of subsidy for infrastructure entities. This not only distorts • Occupational or employer-sponsored private the measurement of actual compensation pensions: The least common but in some costs on an ongoing basis but may lead to respects most problematic type of pensions demands for a very high payment to settle likely to be encountered in a privatization previously accrued but unfunded obligations initiative is occupational plans. These are when an employer tries to withdraw from special pension arrangements that have been the plan upon privatization. established to cover workers in specific enterprises, sometimes called single-employ- •Provident funds: Former colonial powers, er plans, or a group of related employers or particularly the British, established a partic- members of a trade union, sometimes called ular type of savings institution known as multiemployer plans. Occupational pensions provident funds, and these remain common can be the only source of pension coverage in many developing nations in South Asia in circumstances where there is no national and Africa. These are defined-contribution pension program or where employees in cer- arrangements in which an account is estab- tain industries are excluded from other lished for each participant and the contribu- arrangements. They also can be integrated tion of a specified portion of wages is into other plans, usually designed to provide mandatory. Contributions often must be supplementary benefits where income made by employers as well. replacement rates are low or to provide for Typically the funds are invested in safe but earlier retirement ages. Traditionally these low-yielding assets, usually debt instruments types of pensions have been of the defined- of the government. Participants are often benefit type; however, there is a recent trend permitted to borrow the funds for specified toward defined-contribution plans. purposes—the purchase of housing is a Occupational pensions are extremely diverse common example—and are entitled to in form. They impose particular problems receive the total amount that has built up in for implementing agencies because most their accounts when they reach a specified developing countries have not established age. In some instances provision is made to any sort of comprehensive rules or require- convert the account balance into a lifetime ments for their establishment or operation. annuity. This can result in circumstances in which Although provident funds are primarily the benefits promised are not clearly speci- established as retirement savings vehicles, fied, and that leads to considerable contro- they are often used for a far broader range versy about their settlement. Workers may of purposes. Workers often deplete the full be led to expectations about their pensions

103 Labor Issues in Infrastructure Reform: A Toolkit

Provident funds are that are considerably at odds with the terms its long-term viability. There are several steps defined-contribution of the arrangement or the resources avail- involved: plans. able. Step one: The first step in this process is to obtain a Most significantly, occupational plans often comprehensive understanding of all of the potential result in substantial future financial commit- pension commitments that currently exist. Pensions ments that have not been measured or are an integral aspect of labor negotiations and work accounted for in a reliable fashion and that force management. Although this is typically a for- have no funding set aside to ensure they can mal process, perceptions and expectations are often be met. These problems are especially pro- as important as formal legal agreements. Care must nounced for defined-benefit arrangements, be taken to be as thorough as possible in obtaining a but may also occur when defined-contribu-

MODULE 5 full picture of the existing pension system. tion plans must be funded or when the funding is not segregated from the sponsor’s Pension agreements may be contained in forms other financial arrangements. They do, how- ranging from national laws covering all workers, ever, afford opportunities for using pensions collectively bargained agreements between workers to manage labor restructuring or to provide and trade unions, formal plans outlined in legal incentives to manage a work force, as dis- documents executed by an employer, and informal cussed in subsequent sections. agreements or acknowledged practices by an employer. Many countries do not have well-devel- oped labor codes or pension regulatory regimes Addressing Prior Pension that establish standards for pensions. The extent to Obligations which any of these obligations is binding will depend on the laws and traditions applicable to This section examines the issues and choices that individual circumstances. It is likely that some must be addressed in assessing the feasibility of pri- important practices and expectations will not be vatization and in resolving the existing pension well documented. obligations during implementation. At a minimum the relevant national laws and doc- uments describing schemes for civil servants, provi- Measuring Existing Obligations dent funds, or any employer-specific arrangements will have to be obtained and carefully reviewed to Pensions essentially involve the commitment by an assess the extent of an employer’s pension obliga- employer to provide resources intended to be con- tions. It is generally advisable to consult with offi- verted to income following the retirement of cov- cials of government-operated pension schemes, ered workers. This commitment can be as simple employee representatives, and any staff responsible as an obligation to forward a specified portion of a for an enterprise’s human resources or personnel worker’s pay to an individual savings account (for functions to identify any undocumented agree- example, to a defined-contribution plan or provi- ments or practices that are relevant. A thorough dent fund) or the far more complex responsibility familiarization with any regulatory requirements to fund and administer a program that will provide having a specific focus on funding requirements, a monthly payment to replace a specified portion vesting rules (requirements for the irrevocable right of a worker’s final salary for the remainder of the to benefits when certain conditions are met), and worker’s life (a defined-benefit plan based on final procedures for the resolution of benefit disputes is salary). In many circumstances the cost of these advisable. This process should result in a complete obligations represents the single largest long-term inventory of potential pension obligations. financial obligation of an enterprise. How this obli- gation is addressed will be a key determinant of the Step two: The second and likely far more difficult market value of an enterprise and will be critical to step will be to develop reliable measures of the

104 Key Elements of a Labor Program scope and cost of existing pension obligations. This obtain an accurate assessment. Considerable future Legislation and step can be divided into two components: (1) the problems can result when the actual value or the plans are the essential starting value of pension obligations accrued to date (some- “market value” of assets is at odds with the value points for a review times called the accumulated liability or the shown in workers’ or a pension fund accounts, of pension accrued-benefit obligation) and (2) an estimation of even if it is consistent with applicable financial agreements. MODULE 5 the future and magnitude of pension obligations accounting practices that may require assets to be (variously referred to as the periodic costs or carried at their purchase price until actually sold. It projected-benefit obligations, among other terms). is very important to understand potential differ- ences and obtain a current value in these circum- If the pension obligations are solely defined as con- stances where the actual value may be less, espe- tribution in nature, valuing the commitments to cially if there is a possible obligation of the pension date may be as simple as determining the value of sponsor to compensate for any shortfall. the various accounts and making judgments about the potential expense of fulfilling the contribution Some countries may have established periodic audit formulas in the future. These expenses usually can requirements for pension funds. Unless there is an be readily expressed as either a fixed amount per extremely strong system of auditor quality assur- period, usually a month or year, or as a percentage ance and such an audit has been done very recent- of wages. ly, it is generally advisable not to rely on an exist- ing audit for these purposes. Even the most devel- The most critical aspects of the process for defined- oped systems with strong compliance measures contribution plans usually will be to determine the experience significant problems with the timely for- extent to which contributions to individual warding of pension contributions and the reliabili- accounts have actually been made as promised and ty of their financial statements. When enterprises to identify the extent to which assets shown in face cash flow problems or when managers face account balances are actually present. This process significant uncertainty about their future employ- nearly always will require engaging the services of a ment contracts, pools of assets in pension funds reliable financial accountant to conduct a thorough often are among the most vulnerable to fraud, audit of the records of accounts to verify that (a) theft, or other manipulation. A recent and inde- the accounts have been maintained properly and (b) pendent financial audit is therefore essential in that the assets are present as required or indicated. nearly all circumstances.

Common problems likely to be encountered are Another common challenge in evaluating defined- sponsors who delayed forwarding required contri- contribution plans is the assessment of severance- butions or who substituted promissory notes or type arrangements or other contingent future liabil- other “paper” obligations (perhaps even “shares” ities. Provisions providing one-time payments on of the enterprise) for cash contributions. This is the attainment of a specified age or on the termina- especially common when enterprises face problems tion of employment may be incorporated into pen- raising working capital or other liquidity issues so sion plans, contained in national laws, included in that particular attention should be given under individual employment contracts, or simply a mat- these circumstances. ter of tradition and expectations. The latter espe- An additional challenge will be to determine that cially may be an issue among senior managers. The the value of the assets held in accounts is accurate- cost of these provisions can be of equal or some- ly represented. Investments may be shown at their times greater value than the regular contribution purchase price or some type of “book value,” requirements and should be included in any assess- which may not indicate their current value. In ment of future expected costs. many circumstances the accepted accounting treat- The process for defined-benefit plans is partly par- ment may require these approaches, so particular allel because it also includes a similar need to attention to valuation methods will be needed to obtain a reliable accounting and valuation of any

105 Labor Issues in Infrastructure Reform: A Toolkit

“Book” and funds that have been set aside for pension purpos- Step three: In order to fully and accurately assess “market” values of es, thus imposing a similar need to undertake a the current status of pensions, estimates are also pension plans may be very different. reliable audit. In addition to this, however, is per- needed of the value of supplemental or contingent haps the most difficult and challenging aspect of benefits. These benefits basically are additions to dealing with pension issues—valuing the accumu- the regular benefits paid at normal retirement age lated and future liabilities. and will typically include severance arrangements, provisions for which allow pensions to be paid at Almost without exception this requires the services an age prior to the regular retirement age often of a professional actuary with experience specific triggered by labor force reductions, and additional to pension schemes. This is a process with two benefits paid to workers in dangerous or difficult major elements: (1) obtaining very specific infor- occupations. Because they often are not formal

MODULE 5 mation about the employment history, wages, and obligations until some future event occurs, these demographics of the group of workers covered by kinds of benefits frequently are not included in the the pension plan; and (2) arriving at reasonable accounting for pension obligations. They may, assumptions regarding future patterns of employ- however, be legally enforceable and may represent ment, investment returns, and the life expectancies a substantial portion of the current pension obliga- of the covered workers. The valuation of defined- tions (for example, privilege pensions in Central benefit liabilities, because they often extend and Eastern Europe—see box 5.12). Special care decades into the future, is highly sensitive to the must be taken to identify all of these obligations in accuracy of the underlying information and the initial inventory of pensions and to estimate the assumptions, thus perhaps making the develop- future magnitude of their costs. Assigning some ment of these assumptions the most important probability of these benefits being paid and deriv- aspect of the process. ing a measure of the current liability are often Professional help is often needed for a pension review. major parts of the work of an actuarial evaluation. The CD-ROM contains terms of reference for a pen- sion consultant or actuary. Determining the Funding Status Countries with a long experience of defined-benefit pensions may have standards of practice or legal Assessing the status of current obligations will yield requirements for many of these factors. However, two key measures of the overall financial status of these are unlikely to exist in developing economies. pensions. The first of these measures is often Standards from other countries, because they are referred to as the accumulated- or accrued-benefit based on specific experience with investment obligation. This is essentially a measure of the cur- returns and life expectancies among other key fac- rent value of funds set aside or previously paid as tors, generally are not transferable. Often a starting contributions in relation to the expected value of point for these assumptions can be derived from the pension benefits promised. This amount can factors used by national pension systems, but in the either be expressed as a percentage or other ratio or end an assessment of reasonableness on a case-by- as a net value. Pensions with a negative ratio of case basis will be needed. In most cases the judg- assets (or aggregate contributions) to future benefit ment of a professional actuary will have to be obligations are commonly referred to as underfund- relied on for these determinations. If there is not an ed or are said to have pension arrears. Although established and reliable actuarial profession in a there are international moves to improve the quality country—which is often the case—the magnitude of pension disclosure in financial accounts (see box of the costs and associated future financial risks 5.13), many enterprises in developing and transition may make incurring the expense of engaging the economies will lack good information on their pen- services of an established international firm a pru- sions. The scale of pension obligations and prob- dent course of action. lems of underfunding may therefore not be fully apparent until revealed in the PPI process.

106 Key Elements of a Labor Program

Box 5.12: Privileged Pension Rights in Central and Eastern Europe n some countries, particularly the transition Hungary economies, public sector employees were usu- The government effectively abolished all privi- ally given “pension privileges.” These privileges leged pensions when the country introduced its I MODULE 5 could be enhanced retirement benefits, retire- new state pension system in 1999, with the com- ment at an earlier age than private sector work- pensation being a pension payment to a voluntary ers, or a combination of both. Privileged pen- scheme. So a PPI investor in Hungary would only sions were widespread in these countries. For have to decide whether it would maintain the level example, in Ukraine more than 25 percent of of voluntary contributions that the government pensioners are younger than the minimum retire- was currently paying. Although this is relatively ment age because they were able to retire early easy, there are other issues. For example, workers under privileged arrangements. who are civil servants can withdraw their benefits Privileged pensions are granted for one of two from a voluntary plan tax free. Naturally they main reasons: to compensate for the lower would be reluctant to give this privilege up, and a wages paid to employees and to compensate for prospective employer may have to negotiate the the special type of work that the employee does. continuation of this arrangement when PPI occurs A typical example of the first category is white- or possibly have to increase the contribution rate collar civil servants; the second category would to maintain the after-tax benefit. For both the be typified by airline pilots or coal miners. implementing agency and the PPI investor, how- Most transition countries are reforming their pen- ever, this is preferable to negotiating the total sion systems with three typical outcomes for package with workers and unions. privileged pensions: Russia 1. Abolition, with compensation to workers in the The implementing agency and the investor face form of higher wages that could be invested in some complex legislation relating to pension privi- voluntary schemes leges. The situation is complicated by how long 2. A requirement that workers who receive privi- the employee was working in the privileged pen- leged pensions have these as a condition of sion position but, generally speaking, employers their employment, and that by choosing to have to make an additional contribution to com- work in the sector, they agree to participate in pensate for the loss of pension privileges. The a voluntary plan amount of contribution is subject to negotiation and the vehicle for the payment is likewise compli- 3. Greater transparency of the financial transfers cated. It is possible to pay contributions in lieu of needed to meet privileged pension obligations pension privileges either to the Russian pension in those countries or industries where some plan or into a licensed voluntary pension plan. The form of continued public subsidy has been law gives the choice of plan to the employer, but a proposed (for example, in Ukraine’s coal-min- new PPI investor is likely to be under some pres- ing sector). sure to establish a voluntary pension plan in order to receive the privileged pension contributions.

Whether a pension is part of a national or civil ser- Funding shortfalls also can be present in some vants’ system operated on a PAYGO basis or cov- defined-contribution arrangements where the fair ers only the workers in a single enterprise, the value for the assets is less than the value of accounts. funding status must be evaluated carefully. The col- Severance payments or informal obligations are lection of contributions from public enterprises is rarely funded in advance. When done properly, a often lax and there may be substantial amounts of full measure of the accrued funding status presents a past contributions owed that are not accurately full measure of the financial obligation the enterprise accounted for. Few countries have well-developed is likely to have to resolve at some point and often requirements for the prefunding of defined-benefit can be a major aspect of the evaluation of the future plans, and even when these are present the assump- demand on cash flows as well as overall financial tions used for determining the required level of solvency. The measure of the accrued funding status assets may be considerably at odds with reality. is likely to be the single most important number

107 Labor Issues in Infrastructure Reform: A Toolkit

Box 5.13: Accounting Standards for Defined-Benefit Plans he international accounting standards (IAS •A net pension asset on the balance sheet may 19) for pension benefits, introduced in 1999 not exceed the present value of available Tby the International Accounting Standards refunds plus the available reduction in future Board, require that contributions in a defined- contributions resulting from a plan surplus. contribution plan be recognized as expenses. In • If the net cumulative unrecognized actuarial contrast, the standards for defined-benefit plans gains and losses exceed the greater of (a) 10 have become more stringent, aiming to fully percent of the present value of the plan obliga- expose pension liabilities, and state that: tion and (b) 10 percent of the fair value of plan • Current service cost should be recognized as assets, that excess must be amortized over a an expense. period not longer than the estimated average •All companies must use the projected unit working lives remaining for employees partici- MODULE 5 credit method (an accrued-benefit method) to pating in the plan. Faster amortization, includ- measure their pension expense and pension ing immediate income recognition for all actu- obligation. arial gains and losses, is permitted if an enter- prise follows a consistent and systematic poli- •Projected-benefit methods may not be used. cy. • The discount rate is the interest rate on high- •Past service cost should be recognized over quality corporate bonds of maturity compara- the average period until the amended benefits ble to plan obligations. become vested. •Plan assets and reimbursement rights must be • The effect of termination, curtailment, or settle- measured at fair value. ment should be recognized when the event • Defined-benefit obligations should be present- occurs. ed net of plan assets. Source: International Accounting Standards Board Web site: • Reimbursement rights should be presented as http://www.iasb.org/) “IAS 19: Employee Benefits.” a separate asset.

derived from an evaluation of pensions and it pro- A second element, usually much smaller, is the pro- vides the basis for the key strategic decisions dis- jected increase in wages or salaries that would raise cussed in the following sections. the ultimate level of benefits even if no additional years of work were covered under the arrange- The second element of the funding status is the ments. Although it adds complexity, it is helpful to development of a measure of future or projected distinguish between the two elements because they pension-benefit obligations. This element provides a will enable a more precise evaluation of the costs of measure of the expected levels of future costs that options for addressing future pensions, as discussed would be incurred to maintain the existing pensions. in subsequent sections. Although it should be calcu- There are two potential aspects of this. First, most of lated separately, this second component is usually a projected obligation will comprise the costs associ- combined with the accumulated liability to derive ated with additional periods of employment by the the funding status. covered workers. These costs will include the contri- butions required for defined-contribution plans and PAYGO systems or the additional years of work that will factor into the benefit formulas of defined Resolving Existing Pension Obligations arrangements. It is extremely helpful to distinguish PPI investors will be extremely wary of becoming between the various contributing factors for the pro- involved in circumstances where large financial jection (that is, employment patterns, mortality obligations for previously promised pension bene- expectations, and the like) as it is developed because fits are present or may arise in the future. This these factors will specify the costs and savings of makes the evaluation of the status of pensions as alternative pension strategies. outlined above an essential early task in the PPI

108 Key Elements of a Labor Program planning process. Evidence that all prior pension • Increasing vesting periods (the period of par- obligations are fully addressed, either through ticipation in the pension system after which paid-up contributions or assets set aside that are benefit rights are irrevocable) sufficient to cover their anticipated value, will sub- •Terminating the pension and discontinuing stantially diminish investors’ actual or perceived MODULE 5 any past benefits (in extreme circumstances). risks, thereby removing a significant barrier to pri- vatization. Conversely, the presence of unfunded or The implementing agency should, however, recog- significant future obligations requires the develop- nize that some of these steps may be explicitly pro- ment of a strategy to address them. There are three hibited by law or may be vulnerable to a challenge potential types of strategic approaches with many under commercial or labor codes. variations and combinations possible: The advisability of such approaches is likely to be 1. Renegotiate or modify the past pension obli- determined by the impact on labor relations and gation to bring the liability to a manageable the extent to which government agencies adminis- level tering national or civil servants’ plans are willing to permit entities to withdraw workers from partici- 2. Freeze or “ring-fence” the past obligation and pation and eliminate any future liability for contri- establish a means either to set aside funds to butions that are in arrears. Workers in public infra- meet the obligation or to transfer the obliga- structure entities, especially those included in civil tion and associated risk to another entity servants’ schemes, are likely to represent powerful 3. Establish a viable approach to resolve the political constituencies and strongly resist such past liability by setting aside assets or sched- steps. Public pension schemes operating on a uling the payment of contributions in PAYGO basis and experiencing both short- and arrears on a schedule that is sustainable for long-term financing problems also are likely to the enterprise as a going concern. oppose such approaches.

Reduce Accrued Pension Obligations Freeze Past Obligations The lowest-cost approach to resolving past pension An intermediate approach to addressing past obli- liabilities obviously is to reduce the magnitude of gations is to freeze the existing obligation at its cur- the liability. The viability of this approach is likely rent level and take steps to address it in a manner to be determined by a combination of legal con- that is viable for the future. In this approach the straints and the assessment of potential conse- past pension obligations are honored, but addition- quences to labor or government relationships. The al benefits do not continue to accrue or they accrue simplest method obviously is to renounce any obli- at a different level or in a form more affordable or gation or commitment to previously earned pen- aligned with the anticipated needs of the future. sions or to the portion of those that are in arrears The separation of accrued and projected compo- or unfunded. nents during the evaluation of liabilities should provide a basis for judgments about the potential The capacity to do so will be determined by the cost reductions of such an approach. This decision legal constraints, which should be an integral part is closely associated with the determination of an of the inventory of pensions discussed above. Prior appropriate prospective pension arrangement pension obligations can be reduced through a ret- because closing down existing pensions in this rospective modification of the benefit formulas, manner has consequences for the future design. including steps such as: Alternatives for resolving liabilities include develop- • Reducing the proportion of wages replaced ment of a schedule for amortizing any shortfall for each year of covered work over a period that matches a projected future fund- • Increasing the age at which retirement is ing stream, paying lump-sum settlements to affect- permitted ed workers in exchange for the settlement of the

109 Labor Issues in Infrastructure Reform: A Toolkit

There are three obligation, “laying off” the liability through a con- past liabilities and the obligations from approaches to tract with a life annuity provider or in some cases future ones. Examples of the separation and resolving unfunded pension liabilities. even permitting a public entity to take over the isolation of pension assets and liabilities are pension obligation in exchange for an agreed-on provided by the cases of Tanzania fee or future series of payments. In cases where Telecommunications Company (box 5.14), there is considerable uncertainty regarding the Japanese National Railways (box 5.15), and capacity of an enterprise to fulfill future obligations South American mines. and remain a viable concern, workers may be will- 3. Privatization proceeds: Some countries have ing to accept one-time cash payments of lesser first sequenced the sale of valuable enterpris- present value than the benefits they forgo in the es to build up adequate funds to finance the settlement of future pension rights. labor adjustment, including pension costs. MODULE 5 This process can be considerably complicated Proceeds can either be monetary transfers, when a guarantee of pension benefits has been pro- or—as in the Bolivian capitalization pro- vided by a government agency or when there is an gram (see box 1.9 in module 1)—transfers attempt to withdraw from a civil servants’ or other of government shareholdings in public publicly managed defined-benefit plan that may be enterprises into private pension plans. If the operated on a PAYGO basis. In these cases a nego- PPI investor is willing to take on pension lia- tiated settlement of future liabilities that is well in bilities, but at a reduced purchase price, that excess of the value of contributions to date may be discount is effectively the same as the for- required. gone privatization proceeds. 4. Donor loans and grants: Large sector Fully Fund Any Shortfall or Arrears reform and structural adjustment lending The least controversial and disruptive, as well as programs are a potential source. For exam- the most direct, method of resolving existing pen- ple, World Bank loans financed severance sion obligations is simply to pay their full cost on a packages for redundant workers, including present-value basis. If this is financially viable and pension liabilities payments, in the restruc- desirable it may be accomplished in a variety of turing of the Polish and Brazilian rail sectors ways: and the privatization of Togo’s telecommu- 1. The government budget: For example, the nications sector. German government agreed to contribute 5. Rescheduled liabilities that are paid later US$1.25 billion into a new private pension from the profits of the PPI enterprise: In plan in order to allow withdrawal from the Romania the privatization of the Sidex steel public pension plan by Lufthansa Airlines. factory involved negotiations among gov- That amount would provide half of the cap- ernment, investor, and unions on the ital needed in a new plan to meet the exist- restructuring of arrears of social taxes— ing obligations; the airline would finance the including pension contributions—that had other half (Guislain 1997, p. 78). More accrued. Sometimes, this rescheduling may commonly, where governments take on include the negotiated write-off of some responsibility for payments under existing debts, or the use of debt instruments by gov- plans, the obligation may be paid from the ernment (government bonds and securities) existing PAYGO system (for example, for or by the PPI enterprises (corporate bonds). early retirees in state-managed, defined-ben- An example is the Moroccan Railways efit plans). Corporation, which agreed with the govern- There are five sources of finance 2. Proceeds from the sale of assets belonging to ment of the Kingdom of Morocco to finance to meet any the enterprise: These assets may be rolled unfunded pension provisions by issuing shortfalls in existing into a separate fund that combines existing bonds over a five-year period. pension obligations.

110 Key Elements of a Labor Program

ceeds and public funds from fiscal sources. The Box 5.14: Tanzania Telecom—Pension Plan company transferred the pension liabilities to the Restructuring federal government (López-Calva 2001). n 1998 Tanzania’s privatization agency, the Parastatal Sector Reform Commission (PSRC) López-Calva 2001 (a PPIAF case study). MODULE 5 Iembarked on the privatization of Tanzania Telecommunications Company Ltd. (TTCL). An initial review revealed four pension plans in which employees were enrolled, and significant Pensions and Labor Restructuring unfunded pension obligations that arose prima- rily from the East African Postal and This section discusses how pensions can be used in Telecommunication Pension Fund (EAP&TPF) of labor restructuring because such adjustment is the former East African Community (EAC). often a major part of any process of privatization. These liabilities presented a major problem, threatening to derail the privatization. They had The implementing agency may face difficult pension been transferred to TTCL when EAP&T was issues and negotiations with workers and unions separated into telecommunications and postal during work force restructuring. Pensions can often operations in 1994. represent a large portion of the compensation pack- The government agreed that the privatized TTCL should transfer its employees to a new age for workers in these enterprises, especially if accumulation plan(s) and that unfunded liabili- workers are enrolled in generous industry-specific ties would be removed from TTCL’s balance or civil servant defined-benefit plans. Pension sheet. To facilitate this, a new company called arrangements can also be adjusted to provide incen- Simu 2000 Ltd. was created. It took over TTCL’s tives for workers to leave employment voluntarily unfunded pension liabilities and was required to or used to cushion the impact on those who may be ensure that the future pension obligations from these older pension plans are met. Simu 2000 separated involuntarily. Various approaches with Ltd. took over existing EAP&TPF assets plus many feasible combinations are possible for inte- noncore TTCL assets, in exchange for also tak- grating pensions into a labor restructuring strategy. ing over future pension liabilities. These approaches can be considered in the context Simu Ltd. was mandated to establish a small of two major categories: early retirement programs management team of no more than five employ- and voluntary departure incentives. ees, and to arrange for the sale of some of the assets and the transfer of proceeds to the National Social Security Fund (NSSF). The NSSF invested the proceeds and paid a fee of Early Retirement Programs 7.5 percent of the total sum invested. Simu 2000 Ltd. was required to meet the monthly The least disruptive and contentious way to payment of pensions to the existing ex-EAP&T restructure a work force is to induce voluntary pensioners, and an initial advance was provided by the PSRC to cover this cost for three months early retirement. Whether this is practical is a ques- and the initial administrative cost of setting up tion of cost and of targeting the availability to Simu 2000 Ltd. redundant workers while retaining those who are Source: Parastatal Sector Reform Commission, Tanzania; essential to a going concern. Whether the benefits Adam Smith Institute. are enough to induce employees to volunteer for early retirement will depend on the type of plan offered (defined-benefit or accumulation), the levels Some PPI programs have created special funds to of benefits promised, the vesting arrangements, finance the costs of retirement. In the privatization participant eligibility, and other rules of the pro- of Mexico’s national railway, a trust fund was set gram—as well as employees’ assessment of alterna- up to finance the retirement benefits of those work- tive employment options. ers who retired prior to privatization. This fund was negotiated between government and the labor Early retirement can be structured in three main union, and included part of the privatization pro- ways—by providing:

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Box 5.15: Japan Railway’s Recurring Pensions Challenge “ ver the protests of the seven direct and Central Japan Railway Co.—publicly listed descendants of the former Japanese their shares during the past two years. Because of ONational Railways, the Diet [Japan’s par- falling real estate prices and other factors, JNR liament] approved legislation in October 1998 Settlement not only has been unable to reduce its [for] a 60-year plan to pay off the ¥27.8 trillion handed-down debt but has seen it grow to nearly ($205.9 billion at ¥135 = $1.00) worth of debt that ¥28 trillion ($207.4 billion). remains from JNR’s 1987 privatization. Although The ¥4.3 trillion ($31.9 billion) in pension liabilities Tokyo will shoulder most of the debt, the seven will be taken over by a new company, Japan rail companies created from the now-defunct Railway Construction Public Corp., which, in government railroad will be forced to take on turn, will derive income from selling JNR ¥180 billion ($1.3 billion) worth of unfunded pen- Settlement’s real estate assets, offering more MODULE 5 sion liabilities owed to former JNR workers now shares of JR companies to the public and forcing employed by them. The repayment plan has JR Group firms to pay ¥180 billion ($1.3 billion) of caught the attention of American shareholders of the cost. three of the Japan Railway firms as well as some The JR companies feel that Tokyo is being unfair U.S. legislators. in forcing them to pay an extra share of the pen- At the time JNR was privatized in 1987, it had sion liabilities. When their private pension plans ¥37.1 trillion ($274.8 billion) worth of red ink on its were absorbed into the government’s pension books. The seven companies that took over JNR’s system in April 1997, the administrators of the passenger and freight rail operations agreed to public plan said that the JR Group’s pension assume ¥14.5 trillion ($107.4 billion) of the debt, scheme was under funded by ¥940 billion ($7 bil- while the rest—¥22.6 trillion ($167.4 billion)—was lion). JNR Settlement agreed to absorb ¥770 bil- transferred to a new company, JNR Settlement lion ($5.7 billion) of the liability, and the seven Corp. JNR Settlement was supposed to whittle operating firms took on the remaining ¥170 billion down the debt by selling off JNR assets, especial- ($1.3 billion). The septet now says that the Tokyo ly prime real estate holdings. The company also government is reneging on the deal by making held all shares of the seven JR operating compa- them pay another ¥180 billion ($1.3 billion).” nies and so benefited when the three strongest— Source: Choy 1998, pp. 6–7. East Japan Railway Co., West Japan Railway Co.,

1. An immediate but reduced pension be taken, however, to ensure that the longevity fac- tor used is consistent with the characteristics of the 2. An immediate but enhanced pension to affected workers, who may differ from the broader compensate in part for the lost opportunity population. The estimation of an appropriate offset to earn future benefits should be a relatively straightforward calculation 3. A normal pension beginning at retirement for an actuary who has completed the evaluation age, perhaps with some lump sum at the of defined-benefit plans as discussed in previous time of early retirement. sections. Pensions may remain at a reduced level Each of these three options is considered below. until the worker reaches normal retirement age, or they may remain at a reduced level until death. An With the first option, the worker who retires early alternative approach that can be combined with receives an immediate pension payment but at a adjustments in the benefit level to achieve lower reduced level. A typical adjustment that is “actuari- initial reductions (and thereby strengthen incen- ally fair” is to provide the same benefit formula for tives) is to eliminate or constrain the indexing of each year of service but then to reduce it by 5 per- benefits until normal retirement age. cent for each year below the normal retirement age. Smaller percentage reductions may provide a Statutory provisions may apply, too. For example, similar equivalence if life expectancies are lower, as under Egyptian social security regulations workers is often the case in developing countries. Care must who are aged 50 or above can receive a retirement

112 Key Elements of a Labor Program pension if they retire early. However, the pension is owner or to a future government. Examples reduced significantly from what they would receive include Sri Lanka Telecom (Salih 2000), Chile Rail, if they retired at age 60 (the normal retirement and a similar case in Australia’s rail sector where age). The amount of reduction is determined by a too many employees took early retirement and had complicated formula that distinguishes between to be rehired later under contract. MODULE 5 basic and variable components of wage. The loss of benefits amounts to 66 percent of full benefits for retirement at age 50, 57 percent at age 53, and Incentives for Voluntary Departure 40 percent at age 57 (Assaad 1999, p. 141). Even where severance payments are the core ele- The second option is a pension that is available ment of voluntary departure plans, some compen- immediately and enhanced to cover the opportuni- sation for past pension contributions may also be ty cost of forfeited future benefits. With this necessary. This can be a lump-sum payment or an option, the enhancements may take the form of obligation to pay a pension in the future, or a mix crediting the employee with more years of service of the two. In general, the objective is to make than have been worked (added years) or of giving plans as simple as possible, although complexities an additional lump sum to purchase an annuity for may arise if there are several classes of employees, an extra pension benefit (the lump sum may be different pension schemes, and different incentives linked to years of service or to years remaining required for different groups of workers. until normal retirement age). An alternative to providing early retirement that Although such enhancements create a powerful may better target incentives to specific groups of incentive for early retirement, their costs must be workers or may entail lower costs is to make carefully evaluated. What may appear to be small retroactive changes to eligibility and vesting rules. additions to credited years of service can have large These rules, which are often very specific to the consequences for the funding status that will need pension plan, can significantly affect the incentives to be paid in the future. and motivations for workers accepting early retire- With the third option for early retirement, payment ment or voluntary departure. of the regular benefits begins when the worker who Eligibility rules can be based on age or based on has taken early retirement reaches normal retire- years of contribution or service. For example, only ment age, but there may be a lump-sum incentive workers over the age of 60 may be eligible to payment at the time of early retirement. At Brazil’s retire, or only workers who have a minimum of 20 RFFSA, for example, the company continued to years of contribution to the pension plan can quali- pay the employer’s and employees’ contributions to fy for early retirement. the national social insurance system for workers who took early retirement (for a maximum of five Work force restructuring can result in amendments years, or until the worker reached age 55). In addi- to the rules of the plan. In the case of PPI in Côte tion, the worker received six months’ salary during d’Ivoire rail, negotiations with unions resulted in the first six months after early retirement. the years of work required for pension eligibility being reduced from 20 to 15 years. This enabled a There are several cases where governments have larger portion of the work force to depart or be been so generous in their pension arrangements separated while still preserving the right to future that the plans led either to excessive long-term lia- benefits without the expense of paying out immedi- bilities on government or to the departure of too ate benefits. many staff through early retirement. Essentially these are cases where the implementing agencies Vesting rules in pension plans are often based on have solved their immediate problem by transfer- years of service; for example, until workers have ring the financial obligations either to the new accrued five years of service they cannot receive full

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Implementing benefits. Like eligibility rules, vesting rules and con- Whatever options are chosen for resolving existing agencies should ventions can influence workers’ decisions and their pension liabilities, the pension scheme will be an avoid the temptation to offer generous willingness to adopt early retirement. Although important aspect of the operation of the restruc- benefits today. there is a trend to more immediate vesting, many tured entity. Should the implementing agency set plans still have long vesting periods. Vesting rules terms for future pension schemes, which would can act as a disincentive to workers leaving volun- become a condition of the PPI contract? In general, tarily. that should be avoided as far as possible, and the PPI investor should have discretion to determine The vesting arrangements may also need to be con- pensions arrangements within statutory require- sidered as part of the total compensation package. ments. The way in which pensions are restructured For example, if the principle to be used in downsiz- will affect how investors value an enterprise and

MODULE 5 ing is last-in/first-out, the redundancy package may assess its long-term viability. Providing investors have to take account of forgone pension contribu- with the widest array of choices and flexibility will tions because the affected employees are unlikely to therefore greatly enhance the attractiveness of an have fully vested benefits. entity for privatization.

The details of these rules can significantly affect The extent to which this is possible will depend, workers’ benefits. For example, in the electricity however, on the nature and difficulty of negotia- restructuring and privatization in Orissa, India, the tions among the work force, trade unions, and former Orissa State Electricity Board (OSEB) government. The Lufthansa Airlines pension included employees who had been deputed from review, for example, required agreement between government service. As for the Grid Corporation the government and the company; and when of Orissa (GRIDCO), when the board was unbun- British Coal was privatized, bidders were required dled and restructured into generation, transmission to accept a new pension plan (see box 5.16). and distribution companies, the eligibility rules were less beneficial for these deputees than for If the implementing agency is negotiating a future OSEB employees. Specifically, OSEB employees pension plan, it is essential to consider carefully had their years of service in OSEB carried over to such issues as the following: count toward a GRIDCO pension, whereas former government employees had to have worked for 10 years within GRIDCO before becoming eligible for Box 5.16: British Coal—Negotiated Pension a GRIDCO pension (Ray 2001). Agreements hen the United Kingdom privatized its coal industry, past benefits accrued W (and the consequential liabilities for Future Pension Design funding) remained the responsibility of the gov- A successful privatization will usually require ernment. Investors bidding for the coal mines were, however, required to participate in a new restructuring the pension scheme to take account pension arrangement that had been negotiated of the different concerns of workers, investors, and previously between the government and stake- government and to align the new pension arrange- holders, including the employees (trade unions). ments with the long-term requirements of a priva- This was an accumulation plan but the investors tized enterprise. This section sets out the key con- had no say over the contribution rate. The new plan was only open to retained workers who siderations and potential alternatives in designing had been members of the old (closed) defined- Eligibility and and implementing pension arrangements, including benefit schemes. New employees engaged by vesting rules require consideration of incentives to attract and retain the investor after privatization were able to par- careful scrutiny. workers, the level and pattern (cash flow) of ticipate in a third, completely new, plan that the expenses, and strategies for funding and invest- employer established. ment. Source: Adam Smith Institute, personal communication; DTI 1993.

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• Legal compliance: The plan should be con- consistent with the purposes and scope of a If the implementing sistent with legislation. For example, some pending or anticipated reform of a national agency will be involved in countries require that one contribution rate pension system? restructuring the apply to all participants in order to qualify pension plan, this is

for specific tax benefits, and some do not a checklist of some MODULE 5 key issues. permit the employee contribution to exceed Work Force Management and Incentives that of the employer. Pensions are generally the largest element of com- • Plan viability: Legislation may provide that pensation arrangements beyond the payment of staff transfers to a new employer after priva- wages and salaries. Although the average cost will tization should be on “no less generous” be between 5 percent and 15 percent of a total terms and conditions. That may present a compensation package, depending on the nature of challenge for PPI if it leads to demands, for the pension design and age of the worker, pension example, that PPI investors provide or main- costs easily can exceed the wage bill for certain tain financially unsustainable pension workers. That makes the design of the pension arrangements. Other matters such as program on a going-forward basis a major issue in deemed length of service are also impor- work force management. tant—in this case because of its effect on workers’ pension rights and benefits. There are essentially two main issues here: (1) the nature of the pension and (2) the level of benefits • Plan type and contribution rate: Most PPI or generosity. Contemplating the replacement of an investors (but few trade unions) would want existing pension program will need to take into to see new plans structured as defined-con- consideration both the potential effects of a change tribution rather than defined-benefit in expectations and an objective assessment of the arrangements because defined-contribution future needs of the organization. Concerns about plans make financial risk borne by the spon- retaining key workers or limiting the adverse sor more readily determinable and pre- effects of difficult labor negotiations may signifi- dictable. The decision about plan type will cantly limit the movement toward what might oth- depend on the joint assessment of financial erwise be an appropriate design. risk and labor incentives as discussed below. Depending on the prevailing employment The basic decision of benefit design is the choice conditions in the country, an employer con- between a defined-contribution and a defined-ben- tribution rate of 5 to 10 percent of average efit system. This is a question of matching the wages should be sufficient to provide a gen- attributes of design to the requirements of the erous plan by the standards of a developing enterprise and the work force. Some of the key or transition economy. A further 5 percent characteristics of each type are listed below. contributed by the employee should general- ly replace a significant portion of wages for Defined-contribution plan: long-term workers with a typical life • Value is proportional to wages, with no dif- expectancy of 10 to 15 years after retire- ferentiation by age. ment. • Is highly portable; workers take accounts • Consistency with other plans and national with them. systems: Care must be taken to ensure that • Offers greater flexibility in payout timing any prospective pension arrangement does and options. not set unwelcome precedents for other • Is easily transparent; workers can readily public sector schemes or enterprises. Will determine value. the plan lead to accelerating demands among workers in similar industries? Is it • Financial risk is held by the worker.

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Defined-benefit plan: cant incentives to retain valued workers who are in • Relative value of benefit usually increases their high-productivity later years of employment. with age. The most important point is to recognize that nei- ther model has any particular inherent advantage • Has potentially large costs for early leavers. but rather a set of characteristics that should be • Offers little access to benefits before retire- aligned with anticipated needs. ment. • Value is hard to measure. Anticipated Expenses and Cash Flow • Offers less financial risk for workers. These characteristics make each type of pension The two models also impose differing financial MODULE 5 appropriate for different work force management aspects that must be consistent with the objectives objectives. and constraints of the ongoing enterprise. In the aggregate, if the generosity of the pension is the Defined-contribution plan: same, both models should entail a similar present • Is attractive to younger workers with short value of costs. The timing and pattern of costs, tenure expectations however, may be significantly different. The capaci- • Is effective in attracting scarce skills in ty of an enterprise to meet the cash flow demands mobile labor markets of the short term may be an extremely important consideration in selecting a pension design. • Is more effective in wage-competitive mar- kets Defined-contribution pensions involve constant and predictable cash flow demands. With workers’ • Has greater association with risk takers. accounts usually credited with actual investment Defined-benefit plan: earnings, sponsors are not exposed to volatility in • Is an effective retention tool for older work- financial markets. Defined-benefit pensions involve ers and senior managers the sponsor committing to a future expense that may vary significantly, depending on employment • Is an effective means of protecting invest- patterns or the earnings on any assets set aside to ments in training fund the plan. Although this arrangement may • Is less attractive to young workers with defer cash flow demands to a later date, those highly marketable skills demands are typically far more volatile in their cost • Is less conducive to competition in compen- and cash flow requirements. If there is a require- sation ment or effort to prefund these demands, poor investment performance may impose future expense • Is associated with stability and risk aversion. shocks and changes in assumed interest rates may There are various potential combinations of the make annual funding requirements extremely two basic designs that can merge aspects of any of volatile. The differences are as follows. those characteristics. One approach that is gaining Defined-contribution plan: acceptance in a variety of settings is a hybrid • Has level annual expenses design in which workers are credited with a fixed amount in an individual account that accumulates • Is predictable as a proportion of the wage with investment earnings during the working years. bill At an established retirement age, this account is • Has early and constant cash flow demands converted into a monthly benefit. These types of arrangements may enable an enterprise to achieve • Offers low risk to the sponsor. many of the advantages of a defined-contribution Defined-benefit plan: pension in attracting workers and providing signifi- • Has variable expense and cash flow

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• Potentially defers the cost to later years stances where the benefit formulas create rapidly accelerating or volatile pension expenses. Factors • Has exposure to financial market and inter- such as unanticipated patterns in wage growth, est rate risk inflation, or the future need to restructure the work

• Has potential to produce future cash flow force may create large and unexpected pension MODULE 5 shocks. costs. It is therefore advisable for the sponsor of a defined-benefit arrangement to estimate pension expenses as they accrue (using the services of a pro- Funding and Investments fessional actuary) and to fund them on an ongoing basis. These actions will prevent the build-up of Decisions will also have to be made regarding a unsustainable liabilities that can drive otherwise strategy to fund future pension benefits. In a few profitable enterprises into insolvency if not proper- cases strategy may be dictated by law, although in ly managed. most circumstances involving privatization there is not likely to be a legal and regulatory framework Funding for future pension expenses should be sep- for pensions that imposes significant requirements. arated from the other activities of the sponsor and Defined-contribution pensions generally involve managed in accordance with a predetermined and payment of the full pension expense during the disciplined investment strategy. This result is best period in which the commitment is made. accomplished through the services of professional Individual accounts should be established for each asset managers but will necessitate the formulation participating worker, and sponsors will have to of a general strategy. Developing this strategy is take a significant responsibility to ensure the usually an area in which engaging the services of integrity of the funds through oversight and peri- competent consultants is advisable. A well-formu- odic auditing. lated investment strategy can mean the difference between a successful pension restructuring and one The most challenging issues are likely to be deci- that exposes the enterprise to enormous financial sions about the investment of the funds, whether risks in the future. Success in this regard is nearly these decisions are to be made by the sponsor or always a process of balancing expense against whether a limited menu of choices will be provided potential risks. to workers individually. In nearly all circumstances the level of development of capital markets and the Some common strategic approaches involve the lack of financial literacy among workers will following: require that any assets be held in very safe, profes- sionally managed portfolios that are professionally • Intermediated financial products: In circum- managed. In countries that have developed a sys- stances where there is a reasonably well- tem of licensed pension funds as part of a broader developed market, all of the financial risk of reform (as will be discussed in the following sec- a defined-benefit pension can be managed tion) this should be a relatively simple choice. In through the purchase of investment prod- other circumstances, sponsoring entities will likely ucts. This strategy will increase the cost but need to choose an asset manager and establish remove risk by purchasing intermediated portfolio limits. products such as investments with fixed returns or, if available, a series of annuity Defined-benefit pensions, however, require far contracts in which an insurance company more complex decisions. The sponsor will have to agrees to pay out benefits in return for a decide the extent to which there is a capacity to set preset fee. aside funds in advance. Funding defined-benefit pensions on a PAYGO basis may move expense • Government-issued or -guaranteed bonds: and cash flow patterns into the future but can Government debt is generally safe but pro- expose sponsors to untenable risks in circum- vides very low returns. Investment of pen-

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Defined-benefit sion funds in government debt is often risk • Any restatement of net pension assets and plans present a free and politically desirable, but it will do liabilities in the accounts of the infrastruc- greater challenge than do defined- little to diminish costs over the long run. ture enterprise, adjusted if appropriate to contribution plans. bring them into line with international • Asset-liability matching: Pension funds com- accounting standards monly try to manage risks by purchasing investments whose value moves opposite • Proposed pension system reforms any changes in liabilities. This strategy is • The obligations of the PPI investor under sometimes called “immunization” or “dura- the country’s labor code and related legisla- tion matching.” It is a process that recog- tion, as well as any specific pension plan nizes that the value of defined-benefit obli- rules. gations is very sensitive to interest rates and MODULE 5 seeks to purchase investments such as long- term bonds that will increase in value as a Ensuring Adequate Funds and result of the same factors that might Administrative Capacity increase the level of future liabilities. These types of approaches are complex to admin- Large-scale early retirement programs can present ister but can significantly limit future expo- a challenge for pension plan administrators. First, sure. finance must be found to meet any gaps in the plan funds. Potential sources of finance are essentially similar to those outlined in module 1 of the Pensions: Implementation Steps Toolkit. Second, the administrative capacity to This section outlines key implementation steps for process the applications or to manage a new pen- pensions in PPI. There are three main steps: sion scheme must be considered. For example:

1. Making information available to bidders • In Brazil’s railway privatization, the early retirement process allowed a period of six 2. Ensuring adequate funds and administrative months in which the workers’ net salary capacity continued to be paid while the appropriate 3. Obtaining technical support. paperwork was being processed by the National Social Security Agency (INSS). If payment was not ready within the six- Making Pension Information Available to month period, the railway company would Bidders continue to pay the net salary, but in the form of an interest-free loan to be reim- The data room is a managed facility provided dur- bursed by the retired employee after the date ing the PPI transaction for bidders to examine sup- of his or her actual retirement (Estache, plementary, bulky, or detailed information. Bidding Schmitt de Azevedo, and Sydenstricker documents or the data room should provide infor- 2000). mation on: • In Mozambique workers in the port and • Relevant laws and collective bargaining railway company were members of the pen- agreements sion system for public sector employees. Workers to be transferred to the new private • Details of existing pension plans, including sector concession managers were to have plan rules; certificates of asset property their pensions immediately transferred to the titles; asset valuations; estimates of unfund- INSS plan, but this did not happen because ed liabilities, including key assumptions; and the public sector pension system was insol- estimates of arrears vent. Without the transfer of funds the INSS

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could not enroll workers and the new pri- on pensions and to the potential impact on vate concessionaires could not contribute proceeds from PPI. the employers’ share. The backlog of cases 2. Help in negotiations with trustees, workers, reached 4,000 workers. and other stakeholders. MODULE 5 • In India, the Pension Trust Fund for Orissa’s 3. Opportunity to give investors as much infor- electricity sector was split among the four mation as possible in bidding documents privatized distribution companies and the and data room: This will help PPI investors transmission company. There were, howev- conduct their own due diligence of pension er, significant delays in establishing the dis- issues more quickly. tribution company trust funds, “due to the inability of the unions/associations to elect Box 5.17 gives one illustration of how actuarial the employee’s representatives” (Ray 2001, advisers need to work with the infrastructure enter- p. 33). prise, pension plan trustees, and the implementing agency. The CD-ROM that accompanies this Together with the specialist consultant, the imple- Toolkit provides outline terms of reference for the menting agency will need to take the following engagement of a specialist consultant for a specific actions: PPI transaction. It also offers a job description and • Consult with the relevant pension authori- draft advertisement for the position of long-term ties to identify what is realistically possible pension adviser who might support a PPI office in terms of payment processes. To reach through a number of PPI transactions. accurate conclusions, the agency will have Terms of reference to assess the need for specialist inputs from Job description for a long-term pension adviser. pension consultants, identify specific deci- sions required from government or trustees, assess the available administrative capacity to handle large numbers of early retirement Tools (on the CD-ROM) programs, identify secure payment arrange- Terms of reference for a pension review ments, and develop procedures to verify that Glossary of pension terms correct payments are made to the correct employees. Frequently asked questions about pensions

• Consider whether some type of technical Job description for a long-term pension adviser assistance or training investment may be necessary for new trustees or supervisory board members. Additional Material (on the CD-ROM) Obtaining Technical Support de Ferranti, David, Guillermo E. Perry, Indermit S. Gill, and Francisco H. G. Ferreira. 2000. “Helping Throughout the pension process the implementing Workers Deal with the Risk of Unemployment.” agency will benefit from the recruitment of inde- Chapter 6 in Securing Our Future in a Global Economy. Latin American and Caribbean Studies. pendent pension or actuarial advice for three rea- Washington, D.C.: World Bank. (Provides an sons: overview of income support programs that have been used in Latin America, including severance 1. Assessment and valuation of the pension pay, public works programs, training programs, scheme: This enables the implementing and unemployment insurance.) agency to alert ministers and other decision- Ray, Pranabesh. 2001. “HR Issues in Private makers to the fiscal impact of any decisions Participation in Infrastructure: A Case Study of

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Box 5.17: South America—Working with Trustees and Pension Advisers Description of the Pension Problems and many pensioners were now below the In one South American country, employees in national poverty line. Fear of criticism arising two mining companies and the mines holding from such payments might deter an international company contributed to one pension plan. The investor from taking over the pension program. privatization strategy was to offer the mines sep- How the Problems Were Resolved arately and close the holding company, and an Earlier privatizations in the country had tackled early question was whether there needed to be pensions through pension scheme liquidation or separate pension plans. The pension scheme negotiated handover (such as the transfer of an actuaries advised that there were cost benefits to existing plan to an insurance company) that continuing with one shared pension plan, includ- occurred at the same time the new investors cre- ing lower actuarial, audit, and trustee fees, ated a new pension plan. Under liquidation, MODULE 5 although they recognized that company control existing pensioners received an annuity, whereas of pension plans was important and any cross- others received lump-sum payouts calculated by subsidization was undesirable. Cross-subsidiza- the actuaries or deferred pensions. For the min- tion could arise not only through one firm having ing companies, however, the problems of selling problems with pension contributions but also a major asset—the commercial property—made with differing age and gender profiles and with liquidation an unattractive option. different earnings levels and retirement ages On the advice of the actuaries, the government between the two companies. chose not to create three separate pension plans Significant practical problems emerged in trying to but to establish a notional separation that assess the pension plan’s assets and liabilities. removed any cross-subsidization while enabling One of the fund’s major investment assets, a prop- the plan to continue owning assets in common. erty investment, would be difficult to sell. The title of the pension scheme to the commer- Moreover, the pension trustees had not perfected cial property was undisputed and government— title to this property. When actuarial advisers working with trustees—took steps to perfect the looked at liabilities, they found that they could not title. value the current pension liability because the The actuaries advised that the existing pension company had failed to provide the data on provisions, particularly for those on very low pen- employees necessary to carry out the valuation. sions, could be ring-fenced and responsibility for Moreover, the previous valuation six years earlier payment transferred to an insurance company, recorded a significant liability, and the mine com- although this would result in workers losing med- panies’ actuaries had then recommended an ical benefits that were then being paid by the increase in pension contributions, which the com- company. panies had not implemented. According to the pension plan, this represented a liability of the The government engaged additional financial and company although it was not recorded as such in accounting help to identify missing personnel the company’s accounts. In addition to these two data required by the actuaries, who then updated liabilities, the increasingly poor financial position of the valuation. In its information memorandum for the mines had resulted in their inability to pay pen- investors the government stated that both the sion payroll contributions to the pension adminis- backlog of payments to the pension scheme and trators, which represented a further liability. the increases recommended by the actuaries were company liabilities that investors were to The unions wanted employees to be paid full take on, but that any actuarial deficit (that is, the redundancy payments before privatization, but uncertain financial liabilities) would be settled by also wanted all pension rights transferred and not government through future contributions or set- liquidated. The pension plan rules, however, indi- tled with the investor at the time of payment. cated that only the trustees could make this decision—not unions or the government—and The government made available the services of that employees also had the choice of opting the pension scheme actuary to prospective bid- out. ders who required clarification on pension liabili- ties during the bidding period. Inflation had eroded the value of many pensions, which had been reasonable when first awarded, Source: Adam Smith Institute, personal communication.

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Orissa Power Reforms.” PPIAF case study. World REDEPLOYMENT SUPPORT Bank, Washington, D.C. (Includes discussion of the treatment of pension issues in one PPI transac- Redeployment support aims to help displaced tion—electricity reform in Orissa.) workers reenter the job market or become self-

employed. Redeployment programs are politically MODULE 5 Sin, Yvonne. 2003. “Pension Reform Options Simulation Tool Kit—PROST.” World Bank, and socially valuable, providing a tangible demon- Washington, D.C. (A presentation introducing the stration of government’s commitment to helping World Bank’s PROST methodology; helpful to illus- workers. But program design and implementation trate the inputs that are needed to review very large has to be considered carefully to ensure the cost- or national pension systems.) effectiveness and efficiency of such programs.

Redeployment support aims to facilitate restructur- Web sites ing of the enterprise, the sector, or the economy and to shorten and alleviate the period of unem- Rapid Response: http://rru.worldbank.org. (The site is a gateway to a range of information on infrastrucu- ployment and income loss experienced by dis- ture, privatization, and private sector development placed workers. It is an active rather than passive policies.) labor market policy response. This section summa- rizes the key types of redeployment support and World Bank: www.worldbank.org. (Use the site’s search engine to locate information about pensions the broad lessons emerging from international and specialist sources of information.) experience.

World Bank Institute (WBI): The main types of redeployment support are: www.worldbank.org/wbi/. (The WBI is the training arm of the World Bank and provides courses on— •Prelayoff advice and counseling, which—in among other topics—pension reform. For example, addition to advice on separation and on see: www.worldbank.org/wbi/pensions/courses/ services and support open to the displaced february2003/presentations.html.) worker—may include elements of trauma, financial, and life counseling.

Other Material and Sources • Job-search assistance, which can include placement help (employment intermedia- Bateman, Hazel, Geoffrey Kingston, and John Pigott. tion) to match workers with opportunities 2001. Forced Savings: Mandating Private Retirement Incomes. Cambridge: Cambridge in the job market, time off for job search University Press. (A general introduction to pension prior to termination of employment, and policies.) help in building skills and confidence to find a new job (interview skills, personal skill OECD (Organisation for Economic Co-operation and Development). 1999. Privatisation, Capital Market assessment, writing job applications, job Development and Pension Systems Reform. clubs). Proceedings of the OECD Advisory Group on •Training, which may include retraining and Privatisation, Thirteenth Plenary Session. September 21–22. Paris. (Various papers, see www.oecd.org.) skill upgrading so that displaced workers can find new paid employment elsewhere, Vives, Antonio. 1999. “Pension Funds in and training in small business, microenter- Infrastructure: Regulations and Instrument prise, or livelihoods to help them create self- Design.” Technical Study IFM–119. Inter-American Development Bank, Washington, D.C. (Considers employment and incomes. the potential for pension funds to contribute to • Employee enterprise, through which the infrastructure development) resources and facilities of the PPI enterprise are used to create jobs for displaced workers by contracting out services needed by the enterprise to newly separated workers or by

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There are five main setting up a range of facilities from simple workers to more productive sectors of the econo- types of workspaces to more sophisticated business my. The experience provides several general lessons redeployment support. incubators. in developing such programs: •Efforts to create jobs by looking to local • Implementing agencies should avoid over- government, nongovernmental organiza- selling the programs, especially where jobs tions (NGOs), and community self-help are scarce. In such cases, economic and groups, alone or in coalition, to develop labor market policies that generate sustain- employment opportunities at a local level. able economic growth and job creation are These can include large-scale, labor-intensive key in offering the best long-term prospects public works programs, local community for displaced workers. activities, or small enterprise development MODULE 5 projects. • Although national programs have had mixed results, there are opportunities for the How have redeployment programs worked in implementing agency to design and imple- practice? The evidence shows mixed results. ment more targeted redeployment programs Reviews of retraining and other active labor mar- that tackle the specific needs of workers ket programs (mainly in the industrial countries of from the PPI enterprise or scheme. the OECD) found limited impacts (Dar and Gill Examples include rail privatization in 1995, 1998; Dar and Tzannatos 1999; Fay 1996). Poland, where redeployment and retraining These findings are summarized in table 5.7. The were integral components of the labor pro- evaluations revealed that retraining programs were gram. generally no more effective than job-search help in increasing either reemployment probabilities or Link to the Web site of the Polish rail rede- postintervention earnings, and they were between ployment service: two and four times more expensive than job-search www.kaaz.pkp.pl/en/kaaz.html. assistance. • Setting up a redeployment program takes Although many evaluations have focused on time and is institutionally intensive. An eval- OECD experiences, the few evaluations of active uation of Brazil’s federal railway redeploy- labor market programs in developing countries ment program noted that the main problems also show mixed results, given the capacity, fund- came from underestimating the time it was ing, and infrastructure constraints that many going to take to agree on the strategy to developing countries face. For example, Mexico’s implement the training and the outplacement PROBECAT program, which was enrolling half a programs (Estache, Schmitt de Azevedo, and million workers a year, may have had no effect on Sydenstricker 2000). One outcome was that the employability of trainees (Wodon and the training program was not put in place Minowa 2001). Similarly, Tanzania’s redeploy- until some months after workers were sepa- ment program for more than 60,000 retrenched rated, and many workers had already moved civil servants had no effect on employability, on. Early interventions are beneficial to although the combination of counseling and workers. Experience in industrial and transi- training helped improve subsequent earnings tion countries indicates that displaced work- (Blomquist 2002). ers are better help while they are still employed than after they have been unem- Wodon and Minowa 2001. ployed for several months (Hansen 2001).

Redeployment programs, however, play an impor- • Appropriate incentives for participants and tant political and social role in the labor restructur- service providers are important. Making ing process. When designed properly they can also training more demand-driven through the be economically beneficial in moving unproductive use of vouchers and other such mechanisms

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Table 5.7: Summary of Active Labor Market Program Evaluation Results Evaluations of large, active labor market programs conducted Program Appears to help Comments in OECD countries have shown mixed

Job-search assistance/ Adult unemployed workers Relatively more cost-effective than other labor results. MODULE 5 employment services generally when economic market interventions (such as training), mainly (19 evaluations) conditions are improving; because of the lower cost; youth usually do not women may benefit more benefit; difficulty lies in deciding who needs help in order to minimize dead-weight loss. Training of long-term Women and other disad- No more effective than job-search assistance in unemployed workers vantaged groups increasing reemployment probabilities and post- (28 evaluations) intervention earnings, and is 2 to 4 times more costly. Retraining in the Little positive impact— No more effective than job-search assistance and case of mass layoffs mainly when economy is significantly more expensive; rate of return on There are limits to (12 evaluations) doing better these programs is usually negative. what can be Training for youth No positive impact Employment and earnings prospects are not achieved by redeployment (7 evaluations) improved as a result of the training; taking costs alone—economic into account, the real rate of return of these pro- policies that grams is negative. generate sustainable Employment/wage Long-term unemployed High dead-weight and substitution effects; impact economic growth subsidies workers by providing a analysis shows treatment group does not do well will offer the best (22 evaluations) means of entry into the compared with control; sometimes used by firms prospects for labor force as a permanent subsidy program. displaced workers in the medium term. Public works Severely disadvantaged Long-term employment prospects are not helped; programs (17 groups by providing program participants are less likely to be evaluations) temporary employment employed in a normal job and they earn less than and a safety net do individuals in the control group; not cost- effective if the objective is to get people into gain- ful employment. Microenterprise Relatively older groups Very low take-up among the unemployed; signifi- development and more educated cant failure rate of small businesses; high dead- programs workers weight and displacement effects; high costs; (15 evaluations) cost-benefit analysis is rarely conducted but sometimes shows costs to the unemployment insurance budget to be higher than for the control group; administratively intensive. Note: Based on evidence from around 100 evaluations of active labor market programs, mostly in OECD countries—mainly, Canada, Germany, Sweden, the United Kingdom, and the United States—but with some examples from transition and developing countries such as the Czech Republic, Hungary, Poland, and Turkey. Most of the evaluations were undertaken recently, during the 1990s. Source: Dar and Tzannatos 1999.

is one way to improve the effectiveness of run agencies that lack resources, market orienta- the programs. Another is encouraging the tion, and institutional capacity. Private sector train- involvement of NGOs and private providers ing providers are few or weak. Moreover, employ- through the use of performance-based con- ees themselves often have little faith that training tracts for the delivery of services. will improve skills and help them find alternative job opportunities, particularly when unemploy- Many developing countries face challenges in put- ment is high. All of those factors need to be taken ting in place effective redeployment programs. In into account in the design and implementation of many countries training is still supplied by state- redeployment programs.

123 Labor Issues in Infrastructure Reform: A Toolkit

Good program Design and Implementation of 1. A survey of employees, including the skills, design demands capabilities, and expressed redeployment attention to the Redeployment Programs needs of workers details of selection This section sets out the key steps in designing and and incentives mechanisms. implementing a redeployment program tailored to 2. A survey of the labor market itself, includ- the circumstances of the PPI plan. ing areas of supply and demand 3. A survey of potential redeployment service providers, including the types and capacity Step 1: Define Objectives of existing public and private providers.

Before proposing redeployment support as part of These three surveys could be carried out separately, a labor program, implementing agencies must be but in practice the findings of each will inform the MODULE 5 clear about the rationale for it. Potentially there are design of the redeployment program and close three objectives: coordination is thus required. Outline terms of ref- erence for the various surveys are provided in the • From an economic standpoint, the objective accompanying CD-ROM. is to facilitate the shift of unproductive workers to more productive activities else- Terms of reference for surveys of the labor market, where in the economy. workers, and potential redeployment providers.

• From a social standpoint, the objective is to Employee Surveys help workers acquire the necessary skills to Employee surveys provide a descriptive profile of become reemployed or self-employed. the work force and help the implementing agency • From a political standpoint, redeployment to: programs are intended to build public sup- • Understand the profile of workers in the port for restructuring by signaling to citizens, enterprise communities, and labor representatives that those responsible for restructuring are ready • Identify the most vulnerable groups and willing to help those who need and • Monitor and challenge proposals from rede- want help (Fretwell 2002). Such programs ployment service providers based on a factu- help make difficult reforms acceptable to al information base workers and other stakeholders. In India, for example, trade unions supported the retrain- • Provide a baseline for subsequent monitor- ing elements of the National Renewal Fund ing and evaluation. (NRF) and welcomed this as a measure to The survey can build on, but is different from, the offset the social costs of enterprise adjust- staff and skills audits described in module 7. Those ment and reform (and they were subsequent- audits focus on the needs of the enterprise, whereas ly very critical when the NRF funded mostly the worker survey focuses on the needs of workers severance payments and little training). who will lose their jobs (see, for example, box In the right circumstances, redeployment programs 5.18). The worker survey can also overlap with the can have important objectives. When those objectives stakeholder analysis needed for planning communi- have been clearly defined, the main challenge is to cations and consultation (see module 6). improve the effectiveness of redeployment programs. Stakeholder analysis might be usefully scheduled at the same time as the worker survey.

The worker survey can include: Step 2: Conduct Preparatory Surveys • Assessing the likely plans of employees— Three types of surveys are typically needed early in what proportion will retire permanently, or the program to help inform its design. They are: return to their home towns or villages, or be

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Redeployment has Box 5.18: Brazil Rail—Worker Surveys in a Labor Study economic, social, o minimize the social cost of layoffs, Brazil’s In spite of some similarities, such as the low level and political federal railway, RFFSA, had to have a good of education, the profile of RFFSA’s employees benefits. understanding of the profile of its employ- differed from the rest of labor market. The aver-

T MODULE 5 ees. A detailed study was carried out as part of age rail worker was about 41 years old, had the preparation for World Bank support. A about 18 years of service with the same compa- detailed analysis of the characteristics of each ny, did not have much education, and had few or regional labor market and the outplacement excessively specialized skills. The average work- opportunities for each excess worker was con- er in the general labor market is at least 6 years ducted. The study covered the employee’s age, younger. RFFSA’s workers were paid between 10 experience, and education level, compared with and 30 percent more than the average worker in A redeployment similar characteristics in the regional labor market the respective labor market. program study is essential, and needs where the redundant employees would have to The emerging concern was then that without compete for a new job. to cover three some assistance, many of the rail workers aspects: The study revealed that the two main character- declared redundant were likely to find it difficult istics of Brazil’s labor market are (a) the modest to compete in the labor market in the short run. • The labor market qualifications of its labor force and (b) its capacity Even if these workers did manage to reenter the itself to generate jobs of poor quality. The poor qualifi- market, they were likely to be paid less. The view • Redeployment cations of the country’s labor force reflect the low at that time was that what was needed was service providers level of formal schooling and the low quality of enough training to reduce the cost imposed by • The characteris- basic education. Professional training is not specialized job experience and the lack of formal tics of displaced entirely effective, even for the most educated education. A team of advisers from various train- workers. workers. Moreover, training on the job is often ing institutions was convened by RFFSA to pre- not sufficient because of the high turnover in the pare a menu of options from which affected labor market. There are frequent short spells of employees could choose, and to design training unemployment. In many cases these spells result packages that would meet the employees’ in lower wages when workers return to the mar- needs. ket. There is also an increasing trend toward Source: Estache, Schmitt de Azevedo, and Sydenstricker switching from the status of employee to that of 2000. independent businessperson.

willing to migrate to find alternative The outcomes of the survey can help in designing incomes? the scope of the labor program. Those at highest risk are unlikely to find jobs quickly and will bene- • Developing descriptive profiles of the workers fit from job-creation activities (public works, sup- being retrenched through individual inter- port for small enterprise, and community pro- views and focus-group discussions. These grams) as well as access to income support. Those meetings can provide a description of different with the most skills and highest level of mobility groups of workers that bring to life—for deci- may benefit more from job-search assistance skills sionmakers—the risk profiles, key concerns, upgrading or retraining. and challenges faced by different groups. (Box 5.19 describes such risk profiles.) Worker surveys are an important input into the • Assessing worker preferences in terms of design and implementation of redeployment pro- severance packages (one-time lump-sum grams and must be designed with considerable Can the survey of workers be payments, phased payments, or salary con- care. An example of such a survey is included on the CD-ROM that accompanies this Tookit. scheduled at about tinuation). the same time as a Design, implementation, and analysis of the survey stakeholder • Learning from the experiences of other can be subcontracted out to national consultants analysis? workers, perhaps in other sectors, who have or to academic or policy institutions. recently retired or been retrenched.

125 Labor Issues in Infrastructure Reform: A Toolkit

Box 5.19: Ukraine—Profiles of Displaced Coal Mine Workers Level One—Highest Risk when the mine closes. She is frightened when A woman, alone with children, with 70 percent or she thinks about it closing. No one will hire her. more of the family income derived from mine Level Three—At Risk wages, is in level one. People like this are clearly Underground workers in the engineering and the most at risk of losing everything. other professions form this group. They are the Example: L. N. is 35 years old and has lived in highest-risk group of the underground workers. the community all her life. She has two school- Example: V. G. is a 40-year-old man who has age daughters. Her ex-husband moved away worked 25 years in the mine. He is an electrician and provides no child support. She has worked under ground and earns $64 a month to support in the mine five years as an unskilled above- his wife and two school-age children. He is total- ground worker and earns US$32 a month in total MODULE 5 ly dependent on the mine. His wife is unem- family income, all of which comes from the mine. ployed, and 100 percent of the family monthly Her job will be one of the first to go and is not income derives from the mine. He has no savings considered to be transferable to another mine. and worries that the mine closing is going to be a She is very worried about how she will take care disaster for his family. of her children. Level Four—At Risk but Mobile Level Two—High Risk Underground skilled workers (face miners, Other aboveground workers make up this cate- drifters, timbers/fitters, and coal transport work- gory. As a general observation, aboveground ers) have the best chance of adjusting to mine workers are considered a highly vulnerable group closure. They are potentially the most in demand of workers, not possessing particularly transfer- for their skills and hence the most mobile. able skills. All female staff work aboveground, Example: O. Z., 38, has worked under ground in and 83 percent of the total number of above- the mine for 19 years, most recently handling ground workers (1,389) are women; 17 percent explosives. Seventy-five percent of his family (285) are men. income derives from the mine. His wife earns $18 Example: V. C. is 60 years old and has lived 60 a month working in the hospital, and he is wor- years in this community. She has worked 30 ried about the future for his two sons. Where will years in the same mine. She currently works they work? He has lived in the same community above ground in the stockyard in an unskilled his whole life and does not want to leave for position. She and her husband have a monthly another job. His skills considerably improve his family income of $64, which includes their pen- chances of getting a new job. sions. Their family income is closely tied to the Source: World Bank 1996b. mine, and it will be cut in half, to about $1 a day,

Labor Market Survey •Probability of finding formal and informal The supply and demand for labor and skills rele- sector employment vant to the workers leaving the infrastructure enter- • Patterns of employment in the private sector, prise will form the core of the labor market survey. including changing hiring practices and skill The survey typically would include assessments of: requirements • The capacity of the labor market to provide • Any barriers to entry into and exit from for- new formal jobs through estimates of job mal employment. creation, job destruction, and labor turnover in the economy The labor market survey needs to consider both the formal job market and the informal sector •Trends in formal and informal employment because the latter is often a major source of and areas of job growth and decline employment. In South American and Caribbean • Alternative employment opportunities, countries, for example, the informal sector repre- including levels of wages and benefits and sents typically one-third to one-half of the work any trends force (Freije 2001).

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Labor market surveys should not be seen as a one- time exercise. Follow-up studies on a periodic basis Box 5.20: Tanzania—“Invisible” Service can detect trends and changes in the labor market, Providers fill in any gaps in understanding, and improve the espite the hostile environment for private quality, relevance, and targeting of redeployment enterprise in the 1970s, the commercial MODULE 5 activities. Ddistrict of Dar es Salaam still hosted many small, private business service Survey of Redeployment Service Providers providers—bookkeepers and accountants, for- warding and courier agencies, marketing A survey of service providers is the third important agents, and business training establishments. source of information in the development of a These small businesses seemed to be invisible redeployment program. The main objectives of the to the donor agencies and to the government, survey are to: both of whom preferred to set up high-profile central promotion facilities. Yet these microfirms • Identify the full range of available service were operating as profitable commercial busi- providers, including public and private ones nesses; they understood the market and the and NGOs, as well as smaller organizations business environment. To the outside observer it seemed that the small accounting offices, for that are often invisible (see box 5.20). example—stimulated by increased demand and • Identify the types of programs they offer with some technical help—could be the seeds of future accountancy, business advice, and and any gaps in services. consultant service firms. But they had to com- •Assess their capacity to deliver such servic- pete with donor-financed facilities working out es. Where there are shortages of service of expensively staffed and equipped offices and providing free services. Fortunately for them, the providers, the implementing agency may local knowledge and the marketing efforts of need to design the program so that service these state-sponsored bureaus were weak, so providers from outside the region are invit- the local service suppliers were not seriously ed to provide services in partnership with damaged and largely retained their traditional local providers, or so that incentives to “invisible” customers. It was an opportunity wasted, however, because these existing fledg- develop the market are provided through ling service firms themselves would have bene- instruments such as vouchers (see Steel fited from advice, training, and incentives to 2003). upgrade so as to contribute to enterprise growth and improved governance. Steel 2003. Source: Phillips 2000. • Assess the performance of service providers in placing recipients or trainees in jobs. This can help determine appropriate performance measures to be included within performance Public works contracts for service providers. Supplementary Community approaches elements Employee enterprise

Step 3: Identify the Main Components of the Core elements Program Counseling of a redeployment Job-search assistance Counseling, training, and job search lie at the core program Training of most redeployment programs (figure 5.2). Job creation, community approaches, public works, and employee enterprise are supplementary ele- ments that can be appropriate in some circum- stances. Figure 5.2: Core and Supplementary Elements

127 Labor Issues in Infrastructure Reform: A Toolkit

The labor market There is no one best model for redeployment pro- levels of activity rates are reported by training study should grams. Country-specific and enterprise-level cir- providers—they can significantly distort participa- analyze both the informal and formal cumstances influence the types of redeployment tion in redeployment plans. Several such plans sectors. components that are selected. Every situation will have high dropout levels. Workers attend the be unique, but some guidelines for when various courses while they have no other income, but as redeployment measures are most likely to be soon as they get a job they leave. appropriate are set out in table 5.8. Increasingly, plans are moving to no or minimal stipends: Step 4: Design Appropriate Incentives • In Trinidad and Tobago, training programs Poorly designed redeployment programs may have run by SERVOL (an NGO primarily work- MODULE 5 little economic effect. To improve economic bene- ing with poor youth) only provide training fits, redeployment activities need to be structured with a small stipend that is set low enough Weaknesses in the in a way that creates appropriate incentives for to prevent participants from dropping out of provision of training are common. The workers and service providers alike. formal education and enrolling merely for implementing the stipend. agency will need to An example comes from Chile, where training for assess these as part displaced workers is provided through the • In India (Orissa and Andhra Pradesh), of the labor market National Training and Employment Service stipends for workers made redundant by the study. (SENCE), part of the Ministry of Labor and Social privatization program are kept at low levels. Security. More than 1,700 training providers to the • In Brazil’s rail privatization, a postprogram program are registered, including private firms, review proposed that at least part of the municipalities, or universities. Funds for training stipend should have been paid when train- are awarded through competitive bidding (publicly ing had been completed. tendered) among providers, and must include com- mitment from private firms for a three-month It is sometimes argued that the stipends given dur- apprenticeship for trainees. The program design ing training are social protection transfers. If this is helps ensure a degree of training relevance because a major issue for a large PPI scheme, then other both firms and training providers have incentives mechanisms for targeting vulnerable workers and for monitoring quality (Freije 2001). providing a social safety net need to be considered, such as a public works scheme or a broader social Table 5.9 summarizes incentive mechanisms that fund program. the implementing agency could adopt in a rede- ployment program. These are mechanisms for Cost Sharing and Vouchers selecting the recipients of redeployment assistance One approach to making programs more effective and performance incentives for public or private is to introduce some element of cost sharing. Giving There is no one best service providers. workers a choice between obtaining training or get- model. ting the equivalent amount in cash as part of sever- Specific incentives that can be adopted include ance pay is one way. Making a small deduction or avoiding or reducing stipend payments to employ- charge for training is another, but this can chase ees who attend activities; cost-sharing by partici- away the poorest workers. A compromise approach pants (especially for such services as training), is to offer free training for the poorest workers—for including through vouchers; and performance- example, those with severance compensation below based contracts for service providers. a defined amount—and then establish a sliding scale of (still modest) charges for other workers. Avoiding Stipends Many programs offer generous stipends to workers Another mechanism is the use of vouchers (either who attend the training programs. Although free or at some cost) to allow workers to select stipends encourage attendance—and hence high their own programs. Vouchers have been used as a

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Table 5.8: What Works Best When?

When it is most appropriate Activity or likely to work best When it is unlikely to work well MODULE 5 Counseling and • Can be effective as a mechanism •Is conducted too late (that is, after prelayoff support to provide information to workers if workers have left the enterprise). delivered efficiently, and on time • Is not supplemented by other (that is, before severance). redeployment services. •Is useful as a screening mechanism to identify workers most likely to demand and benefit from training or other support. •Works best where unemployment is frictional (that is, there are job vacancies but workers face infor- mation gaps) rather than structural (that is, workers lack the skills or live in the wrong places to fill exist- ing vacancies) or where there is a lack of labor demand (that is, too few job vacancies).

Job-search •Works best where unemployment is • Informal economy dominates. assistance/ frictional rather than the result of • Economy is depressed and formal placement/ skill mismatch between workers work opportunities are few. employment and vacancies or a lack of labor •Country is small and private, and information demand. informal networks (that is, friends, exchange services •Country is large and job opportuni- family) are the most important ties are available for workers with sources of job information. existing skills in other regions. • Public employment services (PES) • Public employment service is trust- are weak, highly decentralized, and ed by workers and employers and have little capacity to provide a offers effective employment inter- national labor information mediation services. exchange. • Government has deregulated to •Workers don’t trust PES (perhaps allow the private sector also to pro- because they also monitor unem- vide placement services (with costs ployment benefit fraud). funded by the employer to prevent • Employers don’t trust PES (per- potential abuses of workers). haps because they also regulate • There is a local tradition of worker labor standards). migration, nationally or internation- • Private sector placement and inter- ally. mediation services are still illegal or excessively regulated. Skills-based • Economy is growing reasonably • Formal sector job opportunities are retraining/skills fast and employers are hiring, but limited. upgrading for displaced workers lack appropriate •Workers are illiterate or have a very employment skills. limited skill base on which to • There is a local tradition of worker upgrade. migration, nationally or internation- • There are barriers to entry into ally. employment (regulations on demarcation of jobs).

(Table continues on the following page.)

129 Labor Issues in Infrastructure Reform: A Toolkit

Table 5.8 (continued)

When it is most appropriate Activity or likely to work best When it is unlikely to work well

Training for •Economy is diversifying or under- •Economy is stagnant or in reces- self-employment going rapid structural shift to serv- sion; the formal sector is moribund ices (e.g., in transition economies, and not providing work for the India, and China). informal sector. • New entry into small business is • Economy is highly regulated, with relatively easy, and economies are excessive red tape that restricts substantially deregulated. small business and microenter- • There are personal networks that prise start-ups. MODULE 5 can provide capital and support for • Strong culture of the public sector entrepreneurs. remains; workers expect “guaran- tees from government” for new businesses.

Employee enterprise • PPI schemes have potential to con- • Country has strong laws or tax dis- tract out services (such as meter incentives against contracted labor. reading, construction, facilities • Strongly negative attitude exists maintenance, infrastructure mainte- toward subcontractors by man- nance, and minor works). agement or trade unions. • PPI schemes have managers com- •Continuing underemployment with- mitted to developing a flexible work in the PPI enterprise conflicts with force and helping contractors suc- plans to contract out services to ceed. former employees. • PPI operators have no effective disciplinary control over rent-seek- ing contractual practices.

Community-based • There is a history of civil society • There is profound conflict among programs institutions (including trade unions) ethnic groups, factions, or interest that can propose and manage local groups. demand-driven projects. • Initiatives can be captured by vest- • Decentralized local and municipal ed interest groups. governments are effective, capable, and trusted. • Formal sector employment oppor- tunities are weak.

Public works • There have been massive layoffs, •Political interference and patron- programs with significant numbers of workers age systems lead to excessive needing a temporary safety net spending and misdirected support rather than a “trampoline.” (that is, not to the poorest people). • Formal and informal economy and • National minimum wage is relative- income opportunities are both ly high and can’t be reduced. weak. • Government regulations will not •Vulnerable groups or regions can allow self-targeting of the poorest be identified and resources target- people through low payments ed there. (e.g., there is a mandatory mini- • Activities are demand-led by local mum wage). communities and NGOs. • Self-targeting is possible though rationing support to the poorest and most vulnerable people (e.g., through low wages, queuing).

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Table 5.9: Mechanisms and Incentives for Redeployment

Selection mechanisms Performance incentives for Activity for displaced workers service providers MODULE 5 Counseling • No active selection required; should • Performance bonus to contractor if reach all workers and spouses counseling reaches above a minimum percentage of workers Job-search • No active selection required; should • Competitive bidding for job-search assistance/ be open to all workers assistance placement/ or • Placement agency gets bonus for employment • Self-selection by payment of a every worker still in job after, for information minimum fee (cash or voucher) example, 3 months exchange services Skill-based • Counseling as a means of screening • Competitive bidding, plus quality con- retraining/skill and matching workers with courses to trol criteria for program accreditation upgrading for improve the impact and relevance of of training institutions employment the training • Penalties imposed on training agency • Self-selection by payment of a for dropouts (monitored by independ- minimum fee (cash or voucher) ent auditor) Training for • Counseling as a means of screening • Competitive bidding, plus quality con- self-employment and matching workers with courses to trol criteria for program accreditation improve the impact and relevance of of training institutions the training • Bonus for training agency for every • Self-selection by payment of a worker still in job after, for example, 1 minimum fee (cash or voucher) year (according to monitoring program)

Employee • Active selection on the basis of • Commercially oriented enterprise, enterprise objective appraisals of the business incubator, or managed workspace plans receives revenue benefits from •Active selection by managers of successful cases incubator or managed workspace Community-based • Self-selection of possible community • Staged payments for activities programs projects, as proposed by community • Transparency and audits •Active selection of projects on the basis of (a) cost-benefit ratio and (b) social or poverty impact •High levels of transparency in the community on the amounts and use of funds; independent auditing Public works • Active targeting of vulnerable groups • Performance-based contracts for programs and geographic regions/locations services (e.g., transportation and • Self-selection of the poorest supply of materials) displaced workers through mechanisms such as low pay (perhaps below minimum wage) and enforced queuing

131 Labor Issues in Infrastructure Reform: A Toolkit

tool for obtaining training and business develop- • The client group is well defined. ment services in Ecuador, Paraguay, and Peru. The • Concerns about distortion of the market are experiences of these projects are relatively well doc- less significant because funding for any type umented (see, for example, Bothelo and Goldmark of redeployment training will distort the 2000; Goldmark and Fitzgerald 2001; and market for redeployment and training serv- Goldmark, Bothelo, and de Andrade Orozco ices. 2001). Other examples are: • There is less concern over the sustainability •A pilot program for the use of training of the program—it ends when the last group vouchers was launched in the Republic of of workers has passed through it. Korea in 1998 (Betcherman and others • Self-selection occurs when there is a charge

MODULE 5 2000a, 2000b), and vouchers were pro- posed for training redundant workers in the for the voucher because workers who do Ukraine coal mines (World Bank 1996c). not intend to use it do not buy it. In the Kenya project a charge of 10 percent was •Tanzania’s Civil Service Redeployment made. Even so, about 37,000 vouchers were Program has used vouchers for both coun- issued and 32,000 persons trained. seling and training of some 63,000 retrenched employees (Blomquist 2002. • The voucher could be traded within families (using identification cards, ration cards, and Blomquist 2002. the like to identify the trainee). This will answer a common request among older • In Kenya a project to stimulate demand and retrenched workers to have a younger fami- supply for training and business develop- ly member trained in their place. ment services for the self-employed, microenterprises, and small businesses used The problems that the implementing agency will a voucher mechanism. The demand-driven face regarding vouchers are likely to be linked to approach led to most training being provid- administration and to the training institutions ed by small-scale, but more experienced, pri- rather than to participants. For example: vate sector master craftsmen. It also helped expand, diversify, and customize the supply •Programs may be complex and costly to of training, and helped link the savings and administer. credit associations of microentrepreneurs • There may be a shortage of training with microfinance institutions (see Steel providers willing to participate (although 2003). the introduction of vouchers can help to Vouchers help shift from such a supply-driven improve the supply of training providers). approach dominated by the training providers to • There can be attempts at fraud or collusion one in which the clients (displaced workers) have between trainers and workers to share rev- the power to select services relevant to their needs enues among themselves. That risk can be (see figure 5.3). Experience with vouchers, howev- tackled through a combination of independ- er, is relatively recent. Although initial evaluations ent auditing (random checks of attendance of programs are promising, there is insufficient evi- at training courses, postcourse interviews dence to recommend widespread use. Nonetheless, with trainees), regular monitoring of per- they do address some of the fundamental deficien- formance, and annual or biennial competi- cies in training provision. A voucher program tive rebidding of the contracts for training. tightly targeted at displaced workers has a number Performance Contracts of potential advantages over other types of voucher More demand-driven programs can also be encour- schemes in that: aged, without the complexity of vouchers, through

132 Key Elements of a Labor Program

Vouchers for Supply-driven model Demand-driven model training may be particularly relevant for redeployment programs. MODULE 5

Provider is dependent on the Provider is dependent on government/donor client (the displaced worker)

Government/ Training Government/ $$$ Training international provider international (Vouchers) provider $$$ donor donor

$$$ (Vouchers)

Displaced Displaced worker worker

Figure 5.3: Moving from Supply-Driven to Demand-Driven Training Source: Adapted from Goldmark, Botelho, and Orozco 2001 (annex 2). transparent, competitive procurement, regular • Agree on the institutional home for the rede- retendering, and performance-related contracts for ployment program. There are various suppliers. In Turkey’s privatization program, for options: one is to place the team in the example, negotiated job placement rates were implementing agency; another is to have a required in the contracts of service providers (at group such as the ministry of labor run the minimum levels of 10 percent for counseling and job program. In either case, implementation of placement services and 60 percent for retraining). the actual program is generally subcontract- ed to private sector or nongovernmental The reporting and publication of performance data institutions. can also support performance contracts. If poten- tial program recipients gain access to good infor- • Obtain the necessary expertise. The manag- mation on all training providers and performance er of the PPI implementing agency will have measures (including numbers of other workers many other tasks and will need to delegate selecting the course, dropout percentages, quality redeployment and severance matters to a ratings by former students, and success rates in labor specialist. (See the Toolkit CD-ROM redeployment), they are likely to move to programs for an outline job description for a labor that are both relevant and appropriate for them. specialist.) Terms of reference for a labor redeployment specialist. Step 5: Set up a Redeployment Team • Advertise in well-known national newspa- When the redeployment program has been pers to obtain a prequalified list of potential designed, a key step is to put in place a team to contractors who can subsequently be invited implement the program. The main tasks are to: to bid for redeployment services. Private sec-

133 Labor Issues in Infrastructure Reform: A Toolkit

Experience with tor providers, autonomous public organiza- Step 6: Develop Cost Estimates and vouchers is tions, and NGOs will be eligible and should Funding Arrangements relatively new. be able to demonstrate minimum capabili- ties (that is, prior experience and track In addition to program activities, funding will need record, financial resources, in-house staff, to cover the costs of: and staff qualifications). • Administering the program, including the • Consider working with other government costs of labor experts, counselors, and the agencies to establish a rapid response facili- like Workers need ty. These facilities usually comprise an early • Monitoring program progress and overall honest, transparent warning system to predict the timing of information on the gross effects on workers large retrenchments, prelayoff advice, and

MODULE 5 quality and performance of the rapid mobilization and coordination of • Evaluation of the net impact at the end of courses. supporting public services (see Hansen the program. 2001). Experiences in industrial countries These funds should be linked to the overall timeta- have been adapted in some developing and bles for PPI and severance because there is little transition countries; for example: point in releasing funds for a labor program before – Canada’s Industrial Adjustment Services basic approvals for PPI have been received. provided on request on-site, rapid The accompanying CD-ROM provides a spread- response redeployment services, follow- sheet to help develop cost estimates for program ing the announcement of plant closings activities. or layoffs. A committee, made up of management and labor representatives, Spreadsheet (covering counseling, training activities) to funded by government and the company, develop cost estimates for the redeployment program. organized job-search assistance for redundant workers. This approach was Redeployment programs can be implemented and developed and adapted for use in Egypt. funded through national-level labor or unemploy- – The U.S. Department of Labor has pro- ment funds, as has been common in Eastern Europe moted a rapid response facility with a and Central Asia. These funds are typically financed dislocated worker unit in every state. A on a discretionary basis from the state budget, often Labor funds can be a vehicle for a mix national directory of private sector con- with the support of loans from donors and interna- of government and sultants and service providers is available tional financial institutions. The primary objective donor initiatives to enable state governments to quickly of these funds is to enable activities that help unem- directed at creating draw in expertise in counseling, retrain- ployed people get back into gainful employment. employment and supporting ing, and job search (see Where such funds do not exist, or where they serve redeployment. www.dolea.gov/layoff). Variations on this a different purpose than what is required at the PPI approach have been developed in level, separate arrangements can be made in which Romania, where the approach is used as monies are channeled directly to the PPI implement- part of a national program to offset the ing agency or to the group that is directly responsi- effects of job loss arising from transition ble for the redeployment program. (see http://lrp.digi.ro/eng/), and in Hungary (see lgi.osi.hu/resources/ Social funds have also been used in some cases. Social funds are practices/pdf/labor1.pdf). Social funds are special-purpose, public sector more poverty arrangements designed to mobilize resources to Links to the Web sites of redeployment focused, but can alleviate poverty. Social funds differ from labor also support active and rapid response units in: funds in that they are more directly concerned with labor market and • The United States social safety net • Romania poverty reduction and income support rather than initiatives. • Hungary. employment generation. Their activities may, how-

134 Key Elements of a Labor Program ever, support displaced workers, particularly in If rapid response regions of acute unemployment or in single-indus- Box 5.21: Bolivia—The Emergency Social facilities are in place Fund or are being try towns. Social fund activities are generally developed, the demand driven. Social funds do not directly imple- n Bolivia the state mining corporation reduced implementing ment social safety net programs, but rather solicit, its staff from about 28,000 in August 1985 to agency might MODULE 5 Ifewer than 6,000 by the end of 1986. The usefully build these evaluate, finance, and then monitor projects pro- World Bank supported an emergency fund to into the overall posed and undertaken by private contractors, help redeploy the miners. The Emergency Social design of the NGOs, or other groups. Social funds can attract Fund (ESF) was set up as a temporary fund to redeployment substantial donor financing. finance a large number of small-scale, labor- program. intensive subprojects in infrastructure (housing, In the context of retrenched workers, social funds schools, road improvements, erosion, flood con- may serve a range of active labor market pro- trol, and irrigation works), as well as technical assistance and extension programs. grams, such as retraining, microenterprise loans, and public works programs, in addition to social The ESF illustrates some of the benefits of pub- lic works programs. The greatest benefits from and welfare services. In 1985 Bolivia established participating in the program were received by the world’s first Emergency Social Fund to help those who would have been least well-off with- miners who lost their jobs because of economic out it. Although the subprojects originally were adjustment (see box 5.21). It proved so successful intended to employ mostly miners, only 15–20 that it became the model for Bolivia’s Social percent of them were employed under the ESF. Studies showed that although a number of min- Investment Fund set up in 1990 to finance long- ers moved rapidly to new jobs, others were term development of the country’s social services reluctant to participate in ESF projects because and to deal with the more intransigent problem of the pay was low. The subprojects’ ex post rates endemic poverty. of return were generally positive and contributed substantially to reducing the social cost of Further advice on the design and implementation adjustment after the economic crisis of the mid- of social funds is available from the World Bank at 1980s. www.worldbank.org/socialfunds. Sources: Mathieu 1996; Newman, Jorgensen, and Pradhan 1991. World Bank “gateway” for advice on social funds.

• Introduce open competition into the provi- sion of services, and ensure transparency in Step 7: Identify and Commission Service the process of selection and award. Providers •Provide for pilots or phased programs so The implementing agency’s office does not need to that the initial performance of service provide services directly, and many services can be providers can be checked, as well as the rele- contracted out. Terms of reference and contracts vance of the activity. These help deal with should include performance-based payment mecha- the inevitable uncertainty as to what will nisms to encourage performance, with clear per- work best. Pilot activities can then be tested, formance measures and reporting requirements. monitored, reviewed—ideally by independ- This enables the program to be outcome driven ent specialists—and then rejected, amended, (for example, by number of workers employed or or expanded. number of workers with increased incomes) rather • Conduct regular progress reviews that are than numbers driven (for example, by number of linked to incentive mechanisms, such as reg- workers counseled or number of workers who ular competitive bidding for services. attended training courses). • Engage independent auditors and monitors Other measures to improve the quality of service to review and evaluate the service providers. provision are to:

135 Labor Issues in Infrastructure Reform: A Toolkit

Step 8: Monitor and Evaluate the Program place to help displaced workers. There are many types of counseling. Although cost-effective, coun- Module 7 sets out monitoring and evaluation seling is often neglected. processes in some detail and describes a range of performance monitoring measures. The implement- ing agency’s key tasks here are to: Types of Counseling • Set up formal monitoring arrangements (again using independent contractors if pos- The content of worker counseling can include: sible) to provide regular reports on training • Trauma counseling: Job loss is a clear case and other services, and conduct follow-up of potential trauma in the lives of workers, surveys and focus groups to assess how

MODULE 5 and one component of the counseling redundancy is affecting individuals, families, process is to provide support and assistance and communities. to those who are particularly distressed by • Measure against performance indicators, the event. Redeployment counselors may such as numbers of other workers selecting lack these skills and there is scope for the course, dropout percentages, quality rat- involving NGOs with skills in these areas. ings by former students, success rates in • Financial counseling: This is particularly redeployment (see O’Leary 1995). important because severance may be the • Put performance and monitoring reports into largest sum of money a worker receives in the public domain so that workers can make his or her life. Counseling can help people more informed decisions on which services make prudent investment decisions by pro- and providers are appropriate for their needs. viding advice on: This is important because, until training starts, – How severance has been calculated. neither the trainee nor the implementing agency has any real idea how good (or bad) – Options for investing money (choices and the quality of training will be, especially if risks). there are few redeployment service providers – Investing in self-employment. Experience with prior experience in the country. shows that many recipients of severance • Include short-term tracer studies on the pay assume (wrongly) that they need to impact of training on workers. This can invest large amounts to start a business, help identify weaknesses in program activi- when in practice a more cautious “start ties. For example, if a training activity is small and test the market” approach may only preparing workers for (perhaps nonex- be needed. istent) formal jobs, ignoring the informal – The need to protect severance pay from sector and self-employment, then it may fraudulent investment schemes set up to have very limited success. exploit the sudden increase in liquidity in • Adapt the program in the light of perform- a community where many people are ance findings. receiving severance payments. •Provide for an independent net impact eval- – Helping prepare workers (particularly in uation and then redesign as needed. rural communities) for the sudden arrival of large numbers of “extended family” seeking to benefit from the perceived Counseling windfall. Counseling is the first, and minimum, level of sup- • Counseling on job opportunities, redeploy- port that the implementing agency can put into ment, and training services provides infor-

136 Key Elements of a Labor Program

mation to workers on how to find new jobs • Through mobile visits (for counseling or and other income-earning opportunities, as training of smaller groups) well as how to access redeployment services • At job fairs or meetings; in the community, (training, small business support, placement, using facilities of training institutions, local and job-search services). There is some eval- MODULE 5 government, or other partners; at traditional uation evidence (for example, Blomquist meeting places; or in workers’ homes. 2002) that counseling plus training are more effective than training alone. Materials provided for workers should be in their own language. If many workers are illiterate, rede- ployment programs need to make more use of Timing, Location, and Frequency of radio, video, group meetings, and means for pro- Counseling viding information via other people in the commu- nity who meet workers face to face (for example, Counseling can start when the first announcements health workers or workplace “peer counselors”). have been made to workers about potential retrenchment. Two phases can be identified: How much counseling is required? Intuitively, a single session is unlikely to be sufficient to help • Prelayoff counseling, which will focus on: workers dealing with significant job-loss trauma or –Providing accurate information to workers challenges in finding new income. In India practical and their families on severance programs, experience with national and state-level schemes possible training opportunities, the timing has found that repeated visits are necessary. of activities, selection procedures, and treatment of staff housing, among other things. This helps improve workers’ deci- Designing an Effective Counseling Program sionmaking and avoids damaging rumors. Counseling before and after severance is a relatively – Establishing facilities for counseling (and low-cost measure. Hess (1997) estimated counseling job-search assistance), which may be costs on the order of US$100 per worker. In practice located within the workplace or in a sepa- the costs have been significantly lower. In state-level rate facility that workers can easily access. programs in India counseling costs have been esti- • Postlayoff counseling: Counseling during mated at about US$10 per retired worker, equivalent this phase can become more intensive but to about 10 percent of the cost of training delivered should not distract the worker from his or to each worker. The Toolkit’s CD-ROM contains a her own job-hunting efforts. sample spreadsheet that facilitates the calculation of the costs of setting up a counseling program. The workplace is often the best location for coun- seling, particularly for early interventions and Spreadsheet for estimating the costs of counseling. prelayoff counseling. Improving employee accessi- bility to information about training opportunities is Counseling is relatively low cost, but that does not key. Information can be made available at various always mean it will be effective. The implementing locations: agency can improve effectiveness if:

•In the premises of the utility or PPI plan • There is rapid mobilization of counseling (easiest for workers and the most cost-effec- services. In some cases workers may disperse tive location for initial counseling) to their homes very soon after severance so it is essential to deliver counseling advice • In temporary rented accommodations (use- before that happens. For the implementing ful where the redeployment program needs agency this means that operating budgets, to distance itself from difficult separation recruiting and training of counseling staff, process)

137 Labor Issues in Infrastructure Reform: A Toolkit

Severance payments and counseling materials all need to be in • There is some degree of independence of the may be the largest place well before workers start leaving the counseling service so that the advice is not amount of money that workers ever enterprise. A minimum of six months is ide- compromised. This means: receive. Providing ally needed prior to the formal announce- – Keeping counselors independent of tasks prudent financial ment of retrenchment so as to coordinate all advice is a critical that are properly the work of the the resources (staff, materials) necessary to part of counseling. utility/PPI enterprise managers—for set up a counseling program for a major example, the announcement of layoffs or work force restructuring program. the selection of workers for redundancy. • There is early attention to building capacity Counselors should be associated with in counseling. The implementing agency can helping the worker, not with the address this by: retrenchment process itself. MODULE 5 Training and counseling services – Contracting a training provider. – Ensuring that counselors are as inde- can be contracted Counseling is an underdeveloped skill in pendent as possible from the training out to separate many developing countries, and the program. Where counseling and training independent implementing agency may need to look are combined, there is a risk that coun- agencies. to NGOs with experience in disaster selors become sales agents for the train- counseling, conflict resolution, and nego- ing programs and push workers to inap- tiation for “training the trainers.” propriate courses simply to boost the numbers of “trained” workers. – Using competitive bidding mechanisms to identify a range of potential service providers from government agencies, NGOs, and the private sector. Job-Search Assistance Job-search assistance can be valuable because it – Recruiting and training local counselors. helps identify and match workers’ skills to avail- Some programs have successfully selected able job opportunities. Job-search efforts generally young college graduates as counselors for show positive results and, when targeted, can be privatization redeployment programs. cost-effective. Local counselors have the advantage that they come from the same communities as the workers; and their local sensitivities and language skills mean that they can be Employment Services quickly effective when they have had The purpose of job-search assistance (or outplace- induction training. ment) is to reduce the time and transaction costs – Using peer counselors—that is, other that displaced workers would otherwise incur in employees from within the workplace. trying to find new employment. There is evidence that job-search help works, at least in situations • There is rapid feedback from counseling, where the formal labor market is active: gathered by actively seeking out the view of the counselors in the field, not just their The intervention that seems to work best—at managers. Implementing agency managers the lowest cost—is job search assistance should attend some counseling sessions and (sometimes combined with other labor market listen to the counselors as they share their measures) (Fay 1996, reviewing active labor experiences. The best feedback on the real market programs in OECD states). problems that workers face will come from those closest to the work—from workers Public employment services in particular have and counselors and not from office man- served as brokers matching jobs with job seekers, agers. traditionally through physical centers (employment

138 Key Elements of a Labor Program

“exchanges”). Internet technology is also being Counseling is an used in some countries (box 5.22). Box 5.22: Job-Search Assistance—Using underdeveloped skill New Technology in many developing countries. Additional In a comprehensive review of active labor market abor programs associated with the training may be programs, Dar and Tzannatos (1999) concluded restructuring of both Brazilian and Polish necessary to MODULE 5 that evidence suggested job-search assistance could L railways made use of Internet technology develop enough have positive effects and is usually cost effective to deliver information on severance and rede- counseling capacity ployment to displaced workers. for the redeployment compared with other active labor market pro- program. grams. Results, however, were linked to the labor In Chile the National Training and Employment Service has developed a national electronic market conditions—where overall unemployment labor exchange—InfoEmpleo (see www.infoem- is rising, job-search assistance has not had a posi- pleo.cl/)—that holds the résumés of job seekers tive impact. and receives notice of more than 300 job vacan- cies a month. Similar programs exist in Korea Dar and Tzannatos 1999. (“Work-net” at http://www.work.go.kr/worknet/ main.htm) and in the Philippines (“Phil-Jobnet” Assisting Job-Search Efforts at phil-jobnet2.dole.gov.ph/pls/philjobnet/main). In Andhra Pradesh, India, the state govern- In industrial countries, a first phase of job-search ment’s Social Safety Net Program established a assistance is often undertaken on the premises of Web site where workers who have been dis- the enterprise, and involves providing an outplace- placed as part of a series of enterprise closures ment center where workers can: and restructurings could post their résumés. Some workers found employment overseas • Practice and be trained in job-search and through this mechanism, via a private sector interview techniques placement agency in Chennai that had accessed the Web site. • Share experience and gain employment Source: Adam Smith Institute, personal communication. ideas from other workers, perhaps through peer counselors, as members of a job club (see box 5.23), or from visits by other • Managers in the enterprise reduce any Rebuilding displaced workers who have been made redundant potential problems arising from disaffected workers’ confidence earlier workers in the workplace. is an important element of both • Receive other relevant counseling advice counseling and job- (financial, household planning, trauma, life, search assistance. livelihood) Retraining Retraining is often the biggest element of a rede- • Have access to information (books, ployment program, and often the most costly. brochures, video, presentations) on training Retraining can be provided for both formal courses, self-employment options, and other employment and self-employment. The record of resources such programs has been mixed. Retraining needs • Have access to computers (where appropri- to be targeted and made demand driven if it is to ate) for preparation of curriculum vitae and be effective in cost and outcome. for searching Internet-based job prospects. Retraining for Employment Another tool is the provision of an additional peri- od of paid time during which workers continue to Retraining programs to facilitate formal sector receive a salary but can use that time for job employment are a common element in redeployment search. It can help both workers and managers: programs (box 5.24). Courses usually combine a mix of practical and theoretical training and include: •Workers have paid time to find new incomes. • Short-term (one to six months) vocation courses for unskilled and semiskilled work-

139 Labor Issues in Infrastructure Reform: A Toolkit

Box 5.23: What Happens in a Job Club? Box 5.24: Retraining—Chile’s Program for Mine Workers job club is a group of workers who meet regularly together as part of their job- he Retraining Program for Displaced A search efforts. The job club may be sup- Workers is a pilot project organized ported by the implementing agency or by the T recently by the government of Chile with public employment service. Members of the the financial assistance of the Inter-American club can determine their main activities, which Development Bank Multilateral Investment could include: Fund. The program is mainly designed for skilled adult workers displaced by industrial • Receiving job leads from potential employers restructuring and technological progress. The and job-search agencies program is currently focusing on the retraining • Sharing information about job openings of more than 1,000 redundant coal miners. The MODULE 5 •Developing job-search strategies program managed by the Production •Preparing curriculum vitae or résumés and Development Corporation includes subsidies for helping each other complete job applications counseling, retraining, and employment interme- diation services for displaced workers. The pri- •Creating job-hunting teams for moral support vate agencies that provide these services are and shared transportation selected on the basis of competitive bidding •Taking field trips to workplaces that may be and receive a maximum subsidy of approxi- hiring mately US$2,000 per reemployed worker. •Practicing interviews, telephone skills, and Enterprises that hire retrained workers receive a telephone follow-up calls subsidy of approximately US$900 per worker. • Listening to speakers or watching videos The retraining and reemployment program is about different kinds of jobs part of a broader plan for industrial restructuring in the coal-mining region that offers a series of • Getting and sharing information about hous- incentives for private investment in labor-inten- ing, legal aid, medical assistance, and other sive projects. resources Source: Espinoza 1997. • Sharing experiences—good and bad—and talking about how they feel about trying to get a job and the effects of unemployment on training providers in a small-enterprise train- them and their families; planning and taking part in shared social events. ing program (Steel 2002). Training pro- grams can work with employers to provide Source: Hansen 2001. on-the-job training and a commitment to hire a proportion of trainees, perhaps in return for receipt of the worker’s stipend. ers in areas such as taxi driving, basic car- (This approach was used in the PROBECAT pentry, motor rewinding, dressmaking. program in Chile.) • Short-term technical courses for more skilled Generally, training costs are about US$200–$500 employees. For example, the growth in per worker in middle-income countries (see Fretwell information technology services has prompt- 2002). In Brazil’s rail restructuring, however, the ed the popularity of computer training average cost of training was about US$900 per courses among more qualified workers rede- worker, and similar costs were reported for group ployed from privatized SOEs in most Indian training in Hungary (O’Leary 1995). Uptake varies cities. considerably but is generally relatively modest— • In-service training and on-the-job training typically 15 to 30 percent—and depends on labor are particularly valuable. Often these pro- market conditions, the relevance of the training, vide mechanisms where workers can and the level of incentives (stipends) to workers. enhance or extend their skills through work- ing as an “apprentice” to a skilled worker. Fretwell 2002 In Kenya these were the most demanded

140 Key Elements of a Labor Program

It should also be pointed out that governments 2003), as well as a transition into other full- may not want to offer redeployment and training, time employment or formal business. perhaps in circumstances where the broader reform •Workers are often already engaged in part- goal is to reduce a culture of dependence on gov- time self-employment (and their spouses are ernment for services, assistance, and subsidies. MODULE 5 as well). There may be a policy of offering a generous one- time severance package and encouraging a clean • Only a small proportion of displaced work- break between workers and government: ers will have the aptitude for formal busi- ness. For example, a study of OECD and We don’t want to offer redeployment and transition economies found that only retraining. We have offered a generous separa- around 5 percent of unemployed workers tion package, and workers are leaving quietly. will choose to become self-employed (Van If we offer them retraining, they will then Adams and Wilson 1994). expect a job at the end of it, almost a govern- ment guarantee (adviser to prime minister’s From a policy perspective, support for self-employ- office, developing country). ment is an approach that can stimulate labor demand without distorting other aspects of the economic reform process (through subsidies, for Retraining for Self-Employment example). As with retraining for employment, pro- grams to encourage self-employment also suffer Most training for redundant workers has focused from dead-weight loss effects and will benefit from on training for jobs in the formal sector. In part measures to select participants. For example, an this has reflected aspirations of government, imple- evaluation in Hungary and Poland, based on more menting agencies, unions, and workers alike. But than 5,500 follow-up interviews, indicated that retraining for self-employment is also relevant, many of those receiving financial and training especially where formal jobs are scarce. Training assistance for self-employment would probably for self-employment can address upgrading work- have gained reemployment without government ers’ skills for the “informal sector” of casual help. employment and trading, and is best linked to broader small- and medium-size enterprise support. Reasons to focus on the informal sector are that: Employee Enterprise • Many displaced workers have little formal Some governments have helped employees set up commercial or business experience. A com- their own enterprises to contract services that were mon counseling experience is that newly dis- previously provided by the state enterprise, or set placed workers, flush with their severance up workspaces and small business incubators. payments, can have overly ambitious plans for becoming entrepreneurs. Encouraging workers to try out their business ideas and Contracting out Services their aptitudes for business with very small, low-risk, informal trading activities is often Contracted-out services are one way to encourage more appropriate than their investing—and employee enterprise and thus reduce unemploy- risking—most of their severance money in ment among displaced workers. The enterprise an untested business. awards limited-term, outsourced subcontracts to • The state may well provide barriers to entry firms set up by former employees. Those new small to formal business. businesses may then create jobs themselves. • The informal sector can provide income Contracts are usually awarded with exclusivity opportunities that workers value (Maloney periods for a relatively short period—typically no

141 Labor Issues in Infrastructure Reform: A Toolkit

Counselors should more than two years—long enough to provide a caution workers secure environment for the new business to learn Box 5.25: Malawi—Road Maintenance by against overly Displaced Workers ambitious or risky the disciplines required of private enterprise. The business start-ups. limited life of the contract provides an incentive to oad maintenance in Malawi has been them to improve their performance and innovate in transformed from an activity managed by Rthe (former) Department of Roads using order to successfully bid competitively at the end of government road gangs to one that is managed the contract. It also encourages them to devote by a new Roads Authority, where the actual time to finding new work and opportunities from work is undertaken by private sector contrac- other clients. tors. This change did not occur overnight, how- ever, and there was a two-year interregnum Contracting out also may be part of a wider strate- between the old and the new management. During those 24 months, basic road mainte-

MODULE 5 gy for restructuring of the enterprise. Ancillary nance was carried out through contracts issued functions (for example, catering, building and to small contractors by the Department of equipment maintenance) and core functions (such Roads. In practice these were groups of as revenue collection) can be separated from the retrenched workers formed around former main business and the services purchased from pri- charge hands and foremen who provided skills vate providers. In cases where the private sector is and continuity. It may have been somewhat still developing, there may be limited skills and messy, and undoubtedly that was a period of muddling through, but this approach did allow capacity in the market to provide certain specialist workers and the government time to adjust to services. These contracted-out services may con- the new regime and the new arrangements, and tribute to overall employment but need not neces- provided something of a safety net for workers sarily employ the redundant workers. who were displaced from regular government employment. Examples of contracting out include:

• Privatization of service units: For example, • Redundant utility employees being offered in Mexico rail privatization the period guaranteed contracts to undertake work 1990–95 saw the sale of various small facto- such as meter reading: In the privatization ries and workshops that provided services to of the Manila water supply, the two conces- the railway. Many of the workers who left sionaires agreed to give preferred-contractor the company in that period joined the small status to a service cooperative of former factories as workers (López-Calva 2001). In employees for one year (Cruz 2001). In the Bolivia’s railway, job losses in the privatized privatization of Argentina’s national oil railway were partly offset by new jobs in company, about 5,000 retrenched employees maintenance contracting companies (Valdez received supplier contracts for up to two 2002). Road reforms in a number of Sub- years for their approximately 200 newly Saharan African countries have created new formed businesses (Shaikh 1996). opportunities for road maintenance contrac- Cruz 2001 (a PPIAF case study). tors (box 5.25). • Utility companies changing the skill mix, as • Private sector contractors being required to they become more customer and service ori- give first right of refusal to displaced work- ented: For example, Telecommunications ers: For example, following the introduction New Zealand (TNZ) concentrated its in 1992 of the Competitive Contracting strengths on marketing and customer serv- Program, the city of Philadelphia, ice, and outsourced many technical jobs. In Pennsylvania (United States) implemented a lot of cases, staff took early retirement or several programs designed to help public redundancy options before taking up posi- workers in the transition required by privati- tions with subcontractors who were called zation and public–private competitions. The in to do the work (Ross and Bamber 1998). city created new job classifications and

142 Key Elements of a Labor Program

established a redeployment office to match • Reducing the costs of initial business start- Training for the skills of displaced employees with posi- up by providing free or low-cost access to livelihoods or self- employment may be tion openings in other departments. It also sheds, garages, and simple industrial units, as important as, or gave displaced employees preferential con- and allowing workers to keep and take the more so, than

sideration for other city jobs and required tools of their trade with them into their new training for jobs MODULE 5 where the private contractors to give first right of enterprise opportunities for refusal to affected city workers. •Providing an initial period (one to two new employment in the formal sector are Special assistance and training in setting up a busi- years) of guaranteed employment or exclu- poor. ness can be offered because workers may not be sivity to allow the new enterprises to start familiar with all the requirements and principles of up small business. The implementing agency can • Reducing the risks that management or therefore engage specialist small-business develop- trade unions will renege on promises to sup- ment agencies to undertake a selection and train- port the use of contractors in the future, ing program for applicants for contracted-out through contractual clauses agreeing not to schemes. compete unfairly with the new companies If successfully designed, such programs can win the over a longer period (say, five years) and support of workers. Trade unions may be opposed allowing (not restricting) the new companies to contracting out, however, because of concerns to diversify and find other clients, and pub- about workers moving into so-called atypical lic memoranda of understanding or enter- employment and less formal contracts that offer prise policies in favor of the outsourcing and less protection to the workers. contracting out of specified services.

Contracting out can favor redundant Making Employee Enterprise Work Job-Creation Initiatives workers and offer In many transition and developing countries, a pri- opportunities for Not all employees are suited to employee enter- mary problem is the lack of demand for labor. some to start their prise, and not all the new companies formed are own small Initiatives that help create jobs are valuable in businesses. likely to succeed. This is normal—many small busi- many redeployment circumstances, but particularly ness start-ups fail, although ones that receive pro- in regions or monoindustrial towns with high lev- fessional support have a higher success rate. els of local unemployment. These initiatives include The prospects of creating sustainable new employ- public works programs, support for small and ee enterprises can be improved by: medium-size enterprises, and local and community development planning and job-creation incentives • Engaging business development advisers to for employers. screen and select employees with the apti- tude to become small contractors • Ensuring that the plan documentation and Public Works contracts are clear, comprehensive, and Labor-intensive public works programs are mainly coherent so that workers can understand thought of as safety net programs to deal tem- their choices, options, and risks porarily with large numbers of poor people in cri- •Providing professional support to the select- sis. Public works programs can, however, be ed employees through access to business appropriate in PPI labor programs in regions start-up training and microenterprise train- where there is a particular mix of high and chronic ing (with a minimum level of basic business levels of unemployment, lack of formal social safe- training being mandatory) ty nets, and large numbers of vulnerable workers.

143 Labor Issues in Infrastructure Reform: A Toolkit

Privatized service The pioneering Bolivian ESF had elements of pub- units can offer jobs lic works programs within it and was initially Box 5.26: Three-Point Checklist for to some redundant Successful Public Works Programs workers. intended to support redundant mine workers at a time when the economy was very weak (see box o make public works programs cost- 5.21). effective, the implementing agency can T check to see that: Well-integrated public works programs can com- 1. They pay less than the prevailing market bine safety net benefits with community action, wage for unskilled manual labor in the pro- productive investment, and a degree of encourage- gram area. Restrictions on eligibility can be ment for workers to engage in microenterprise avoided by setting the wage rate at a very low level to ensure self-targeting (that is, only (where elements of the public works are contracted those in urgent need of a job take it, and as

MODULE 5 out). Senegal’s public works program, managed by soon as they find better income opportunities AGETIP (Agence d’Exécution des Travaux they will leave the program). d’Intérêt Public), is an example of a public works 2. The labor intensity of projects is higher than program that combines these objectives and has normal, although this may vary if the assets developed transparent, streamlined procedures (see being created have real value for the poor in box 5.26). the area (for example, irrigation or road works that will benefit entire communities). See www.worldbank.org/oed. 3. Where rationing of the public works scheme is required (for instance, where the demand for work exceeds the budget available at the [low] wage level), the program should be tar- Support for Small Business geted at the areas with the most people dis- advantaged by labor adjustment, as indicated Support for small business includes technical advice by a credible poverty impact map. (business development services), microfinance, and Source: Adapted from Ravallion 1998. managed workspaces and business incubators.

Detailed consideration of these types of support is and infrastructure company and seeing how these beyond the scope of this Toolkit, but further may be used to benefit displaced workers. sources of information on each of them is provided at the end of this section on redeployment. British Coal Enterprise (BCE) is one of the early examples of this approach (see box 5.27). The Managed workspaces and incubators deserve spe- BCE experience illustrates the value of very simple cial mention, however, because the assets of the PPI and basic managed workspaces. BCE workspace enterprise can be used to help workers start up a sites were often not attractive new buildings but business in a relatively low-risk way by providing converted former mine operation buildings. Some workspace and facilities. The principal difference national and regional governments have invested in between managed workspaces and incubators is more substantial incubator facilities—some even that incubators try to bring together both physical moving toward high-tech science parks—but nor- space and technical assistance to start-up entrepre- mally they have done so as part of a wider employ- neurs in one location: ment and economic development policy rather than as a strategy to deal with redeployment. Workspaces and incubators can be set up inde- pendent of labor programs and may be wholly pri- Worldwide there is much experience on the design vate or public–private partnerships. The best incu- and implementation of managed workspaces and business incubators. One source of information is bators are themselves profitable businesses, making the National Business Incubator Association. their incomes from tenant rentals. The implement- ing agency, however, will principally be interested in looking at the existing assets held by the utility The NBIA Web site is a source of information on incubators: www.nbia.org.

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Box 5.27: British Coal—Responding to Mine Closure he coal-mining industry presents a chal- £250,000. In all cases only business plans with lenge when mine closure or work force considerable promise of growth were funded— reduction is required. The geological dic- not microenterprises employing one or two peo-

T MODULE 5 tates of the industry mean that the closure of ple. In many cases these start-ups or expanding mines leads to the concentration of redundancy businesses also made use of BCE’s managed in a few areas. In 1981 there were 211 collieries in workspace programs. BCE also managed £3 mil- the United Kingdom, but this had shrunk to 17 by lion from other sources. 2001. Over the same period the number of work- A central feature of BCE’s approach was to unite ers employed in the industry fell from 279,000 to outplacement and funding by introducing man- fewer than 10,000. In response, in 1984 through aged workspaces or small-business incubators. the National Coal Board, the government estab- BCE offered workshops and offices of various lished a public sector job-creation agency for the sizes and types, as well as such shared services Where there is mining areas, British Coal Enterprise. BCE’s as secretarial support, photocopying, and fac- charge was to facilitate the economic regenera- chronic simile facilities. “Easy-in/easy-out” lease terms unemployment, both tion of coal-mining communities. were designed to remove barriers to growth and community BCE focused on the delivery of practical initiatives diversification for the nascent businesses. The approaches and intended to stimulate regeneration of the coal field workspaces made use of former British Coal public works can areas led by the private sector. The three main premises, redeveloping the existing infrastructure provide elements of activities were outplacement services, business and so keeping the costs of conversion low. active and passive funding, and workspace provision. These activi- labor market In many cases the regeneration of existing facili- support. ties were intended to expand the prospects for ties in derelict areas was the catalyst for the labor market by lowering the threshold for increased local economic growth. BCE invested business entry and growth, and by promoting the a total of £101 million during its existence development and expansion of skills. (1984–96) in more than 5,000 enterprises—there- The outplacement program helped about 60,000 by generating some 54,624 jobs (an average of miners through one-to-one counseling with 11 jobs created per business). Overall, BCE esti- career consultants, and help with résumé prepa- mated the investment cost per job created to be ration and proactive job-search techniques. £1,384. About 56 percent of the jobs created Some funding for retraining was also available were derived from business start-ups, and 44 from British Coal. percent from business expansions. The managed The business-funding program aimed to support workshops operation led directly to the creation fast-track financing. Loans of up to £25,000 were of some 16,200 jobs in more than 1,121 units, made available to start-ups and new businesses and itself became a viable commercial enterprise within coal-mining communities, and larger start- (that was subsequently privatized). ups or expanding businesses were able to apply Source: Gore, Dabinett, and Breeze 2000; Tawney and for larger venture capital investments of up to Levitsky 2000.

Local and Community Economic citizen participation in local economic development Development and Job-Creation Incentives efforts.

Community-based approaches are those where In some countries the employers remaining in the communities—including local and municipal gov- community have received incentives to create new ernments—participate in identifying, selecting, jobs. For example, in Cape Verde vouchers were implementing, or monitoring programs designed to given to private employers to provide on-the-job create employment or protect those who have lost training to employees retrenched as a result of pri- jobs and incomes. The approach aims to build vatization. The employers were reimbursed 40 per- community partnerships to improve the business cent of the salary of a retrenched worker for up to environment, strengthen the local economy, and a period of six months (Kikeri 1998). In Poland create jobs for displaced workers. It also helps in loans at prevailing interest rates were made avail- rebuilding the economic foundation and increases able to existing businesses to organize new employ-

145 Labor Issues in Infrastructure Reform: A Toolkit

Incubators can bring ment places for at least 24 months. And in Job description for a labor redeployment manager together workspace Hungary, the employment fund gave grant aid to and business Sample worker survey assistance in one enterprises making investments that would employ location. long-term employed workers. This was, however, Sample questionnaire for counseled workers the most costly form of active labor program— U.S. Department of Labor adjustment model about six times more expensive than individualized training or self-employment assistance in terms of Monitoring and evaluation performance measures for cost per person reemployed (O’Leary 1995). job search assistance services

Typically, the implementing agency or other govern- ment representatives or contractor will help organize Additional material (on the

MODULE 5 a broad-based community task force to conduct an economic assessment and planning effort “owned” CD-ROM) Simple buildings by the community. Community leaders are invited to Dar, Amit, and Indermit S. Gill. 1998. “Evaluating and facilities can be Retraining Programs in OECD Countries: Lessons participate in a structured economic renewal pro- used very effectively Learned.” The World Bank Research Observer as workspaces. gram designed specifically to strengthen the local 13(1)79–101. economy and create more employment and liveli- hood opportunities. Workshops are conducted over, Fretwell, David H. 2002. “Mitigating the Social for example, a six-month period, and residents learn Impact of Privatization and Enterprise Restructuring.” Working Paper. World Bank, the principles of local economic development and Human Development Sector Unit, Europe and are taught how to assess their community’s needs, Central Asia. Washington, D.C. write a local strategic plan, select and design proj- ects, and begin implementing them. Community approaches may be complemented and financed by Web Sites other programs, such as regional development initia- Committee of Donors for Small Enterprise tives, social funds, or labor funds. Development: www.ilo.org/employment/sedonors. Those approaches are particularly relevant where: (The site provides access to guidelines on financial intermediaries and business development services • The PPI plan produces significant employ- for small enterprises.) ment effects on single-industry towns (for The European Database of Business Incubators: example, some ports). europa.eu.int/comm./enterprise/bi. (Site provides access to information on incubators in 28 European • There is systemic and chronic unemploy- countries, case studies, benchmarking information, ment in the region. and a database of nearly 950 business incubators.)

• There are opportunities that will benefit the International Labour Organisation’s International community (for example, conversion of Training Centre: www.itcilo.it (For courses on buildings into not-for-profit workspaces or enterprise development.) public–private business incubators). International Labour Organisation’s Small Enterprise • The PPI plan leads to some resettlement of Development: www.ilo.org/dyn/empent/empent. staff, perhaps because of the relocation or portal?p_prog=S. merger of operating units. National Business Incubator Association: www.nbia.org. (This site provides information about the organization’s publications on business incubation and about annual conferences. NBIA Tools (on the CD-ROM) provides materials and experiences from developing Terms of reference for a redeployment survey as well as industrial countries.)

Terms of reference: Turkey’s Labor Assistance Group Polish Railway Retraining and Re-employment (privatization social support project) Agency: www.kaaz.pkp.pl/en/kaaz.html. (An exam-

146 Key Elements of a Labor Program

ple of an implementing agency for a labor pro- Available at www.unido.org/userfiles/PuffK/ gram.) lalkaka.pdf.

PPIAF: www.ppiaf.org. (Site provides access to other Ledgerwood, Joann. 1998. Microfinance Handbook: PPIAF toolkits, as well as information about PPIAF An Institutional and Financial Perspective. and how governments and other agencies can Washington, D.C.: World Bank. MODULE 5 access PPIAF resources to accelerate privatization.) NBIA (National Business Incubator Association.) U.S. Agency for International Development microen- 1995. A Comprehensive Guide to Business terprise site: www.usaidmicro.org. (Site includes Incubation. Athens, Ohio. papers on the use of vouchers in the delivery of small business development services.) O’Leary, Christopher J. 1995. “Performance Indicators: A Management Tool for Active Labour Webcast presentation on the voucher program in Programmes in Hungary and Poland.” Kenya’s small business development plan: International Labour Review 134(6):729–51. www.worldbank.org/wbi/B- SPAN/sub_kenya_voucher.htm. Robinson, Marguerite. 2001. The Microfinance Revolution: Sustainable Finance for the Poor. World Bank Social Funds site: Washington, D.C.: World Bank. www/worldbank.org/socialfunds.

World Bank: www.worldbank.org. (The site’s search engine can be used to obtain the Bank’s latest oper- EMPLOYEE SHARE OWNERSHIP ational policies on involuntary resettlement.) Employee share ownership can be used as part of the PPI program, as an element of compensation, as an inducement to remain with the operation Other Material and Sources post-PPI, or as part of an employee buyout. This Committee of Donor Agencies for Small Enterprise section outlines those potential roles. Development. 2001. Guiding Principles for Business Development Services. Available at Employee share ownership often has multiple www.ilo.org/employment/sedonors. goals, centered around: Fay, Robert G. 1996. “Enhancing the Effectiveness of • Concepts of redistribution through gain Active Labor Market Policies: Evidence from Program Evaluations in OECD Countries.” sharing of the wealth generated from the Organisation for Economic Co-operation and PPI enterprise. Development Occasional Paper 18. Paris. • Reduction of the principal-agent problem Hansen, Gary B. 2001. A Guide to Worker (where managers behave in ways that hurt Displacement. Some Tools for Reducing the Impact the interests of the firm and its owners). on Workers, Communities and Enterprises. When workers and managers share in the Geneva: International Labour Office. profits of the firm there is likely to be closer Harper, Malcolm, and Gerry Finnegan. 1998. Value alignment among the work force and man- for Money? Impact of Small Enterprise agers and the owners of the enterprise (the Development. London: Intermediate Technology shareholders). Publications. • Reducing opposition to PPI by enlisting sup- IFC (International Finance Corporation). 2002. port from workers. Handbook for Preparing a Resettlement Action Plan. Washington, D.C. In work force restructuring, employee share owner- ship can be used in three ways: Lalkaka, Rustam. 1997. “Lessons from International Experience for the Promotion of Business 1. As a form of compensation to displaced Incubation Systems in Emerging Economies.” workers. Instead of cash, they can receive shares of the enterprise.

147 Labor Issues in Infrastructure Reform: A Toolkit

2. As part of a new incentive or reward pack- 3. If only a limited number of shares are avail- age for workers who remain with the enter- able for allocation to employees, many man- prise. agers would prefer to see those allocated to the remaining work force as a performance 3. As the basis for management employee buy- incentive rather than to departing workers. outs or employee buyouts of units of the enterprise. Shares as an Incentive or Reward Compensation Packages for The use of share transfers or discounts as an incen- Redundant Workers tive to workers is a common feature of infrastruc- ture PPI through privatization (see box 5.28). In an MODULE 5 As part of a compensation package, share transfers analysis of 630 privatizations of infrastructure, are probably best viewed as a supplement to, energy, and other enterprises, conducted by initial rather than a substitute for, severance or early share offer in more than 59 countries, more than retirement. This is true for three reasons: 90 percent of the transactions transferred shares to workers. On average 7.6 percent of the shares were 1. As a social safety measure, share transfers sold to employees, often on favorable terms (Jones are problematic because the benefits that and others 1999). Data for the individual enterpris- workers receive will depend on movements es is available at http://facultystaff.ou.edu/M/ in share prices. Those movements in turn William.L.Megginson-1/. depend on uncertain micro- and macroeco- nomic factors. Implementing agencies Some countries have established the concept or should exercise considerable caution if they principle of employee share transfers in privatiza- wish to promote share ownership as a com- tion laws. For example, Article 14(4) of Nepal’s pensation mechanism; dramatic falls in Privatization Act 1994 states that “His Majesty’s share prices during 2001 are reminders of Government shall make available to the workers share price volatility. Although in the past and employees of an establishment which is to be some workers have done very well from privatized some of its shares free of cost or at a shares, these successes have been in sec- subsidized price.” In Malawi the government tors—such as telecommunications—that encourages employees in privatized companies to have recorded very high levels of growth for buy shares in the form of an employee or manage- a period. A strategy that provides a large ment buyout. In such cases the privatization com- proportion of workers’ post-PPI compensa- mission may offer a discount of 20 percent. In tion and safety net in the form of shares is addition employees may be allowed to pay for too risky an investment strategy—particular- their shares by deferred payment terms or through ly for older workers. Governments, howev- a privatization fund managed by the Investment er, have sometimes offered shares backed by and Development Bank of Malawi, as part of a a guarantee to workers. financing agreement between that bank and the 2. Many developing countries have relatively European Investment Bank. (The fund was so pop- weak institutional environments for their ular that the money originally allocated was capital markets (that is, uncertain property exhausted within a few months.) rights, limited protection of minority share- holders, poor share registration and deposi- tory systems, and weak regulation and over- Employee Share Ownership Plans sight). Combine that environment with a An employee share ownership plan (ESOP) is a work force that has little experience of share mechanism that enables and facilitates employee ownership, and there are significant risks of ownership in a company. As some of the examples governance failure and abuse.

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Box 5.28: Shares as Incentives in Infrastructure Privatization Thailand power: Privatization of the Ratchaburi eral rule, workers were offered 5 to 10 percent of Electricity Generating Holding Public Company the company’s shares at a discounted price. To Ltd. provided for 45 percent of shares retained pay for the shares workers were allowed to bor- by Electricity Generating Authority of Thailand row up to 50 percent of their severance pay, with MODULE 5 (EGAT), 40 percent of shares offered to the public the company promising to repurchase the shares through an initial public offering (IPO), and 15 at retirement at a value at least equal to the for- percent offered to employees through an ESOP. gone severance payments. Therefore, employees The employees received shares at par value (10 could buy shares below market price with no baht/share) compared with the IPO price of 13 cash outlay, with no risk of loss, and a potential baht/share. The aggregate value of the shares for gain if the shares increased in value. The offered to the EGAT employees was no greater resulting enthusiasm among workers led, in than three times the monthly wage bill for all some cases, to workers becoming the largest EGAT employees (Bhoocha-oom 2001). single shareholder group via personal borrowings Bolivia rail: In the concessioning of Bolivia’s rail used to expand their stake. This was the case in networks, the ministry decided to use share the privatization of LAN Chile (the airline), options as a means to minimize risk and promote Metropolitan Chilectra, and the Steel Company share ownership among workers. To access the of the Pacific (Gates and Saghir 1995). In privatiz- option, workers had to purchase one share at a ing ENDESA, the electricity holding company, preestablished book value share price of US$20. broader-based share ownership was encour- The option contract gave workers the right to aged, and the government not only placed 30 buy shares owned by the state or by public percent of the shares on the local stock market shareholders at book value, up to a total of their for the general public but also reserved shares social benefits (one monthly wage per year of for the work force. work). The option could be exercised anytime Mexico telecommunications: To win over during a period of one or two years after the employees to the privatization of Telmex, the closing of the transaction with the private opera- government offered them eight-year loans on tor (it varied among companies as a result of favorable terms from a government bank to negotiations). However, after the opening of the enable them to purchase 4.4 percent of its class economic envelopes (financial tenders), the offer A shares for a total of US$324 million. The bank for the newly issued shares in the case of the held the shares in trust to ensure payment of the eastern network was only 4.6 percent above loan. The strategy was beneficial for workers: by book value and for the Andean network it was 1995 employees had gained some US$1 billion 54.3 percent below book value. Therefore, most in increased share value (Tandon 1995, Wellenius of the workers decided not to exercise their and Stern 1994). options to buy additional shares (Valdez 2001. Ireland telecommunications and post: In July Italy’s Enel: The first stage of privatization of Enel 1998, 11,000 employees were given a 14.9 per- Spa, the publicly owned Italian electricity sector cent stake in Telecom Eirann—Ireland’s state- operator, took place in November 1999. owned telecommunications company, through an Approximately one-third of the capital stock of ESOP, as part of an agreement that included the company was floated on the Milan and New 2,000 voluntary redundancies and changes to York stock exchanges. The offer was well sub- long-established working practices, and that was scribed and included share requests to 70,302 of meant to help prepare the company for its sub- the company’s employees (85 percent of the total sequent privatization in 1999. Previous ESOPs in group work force as of June 1999). In addition, state enterprises (airline and electricity) had been the three main sectoral unions had promoted limited to about 5 percent of the shareholding, establishment of an association of employee but the 14.9 percent Telecom Eirann model set a shareholders (European Industrial Relations precedent that was adopted for other infrastruc- Observatory On-line [EIROnline]). Available at ture and utility firms, including the postal service, www.eiro.eurofound.ie/). An Post EIROnline. Available at www.eiro.euro Chile airline and power: The second phase of found.ie/. Chile’s privatization program included a program that offered low-risk share ownership. As a gen- (Box continues on the following page.)

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Employee share ownership can be Box 5.28 (continued) used as Argentina water: The Argentine government built Manila water: In the concessioning of MWSS the compensation, as an workers’ support for the Buenos Aires water con- concession contract required that the conces- incentive, or as a cession by pledging to transfer to them 10 per- sionaire grant every regular employee an annual means for the cent of shares in the new water company when stock (share equity) purchase bonus equal to not employees to purchase significant the dividends paid to the government for these less than the last basic monthly salary due that blocks of shares. shares covered their book value (US$12 million) year until all of a block of 6 percent of shares set (Alcázar, Abdala, and Shirley 2000). Similar pro- aside for employee share ownership was fully grams were adopted in other Argentine enterpris- subscribed (Lazaro n.d.; Cruz 2001) es. In the case of Argentina Gas (GdE), however, Senegal electricity: In 1999 10 percent of the given the size of GdE relative to the number of shares were offered for sale to workers. total employees, the government decided to give Kenya Airways: In the 1996 privatization of MODULE 5 less than 10 percent of the shares; employees Kenya Airways, the Dutch airline KLM became were offered 3 to 5 percent because of the large the largest single strategic investor with a share- size of the company relative to the number of the holding of 26 percent, but 3 percent of the airline employees (Shaikh 1996, p. 4). was also reserved for staff at the float on the Nairobi Stock Exchange.

in box 5.28 illustrate, ESOPs now form part of the Additional Material (on the structure of privatization programs for infrastruc- CD-ROM) ture enterprises in developing countries. ESOPs are Cruz, Wilfred. 2001. “Addressing Labor Concerns usually: during Privatization: Lessons from the Metropolitan Waterworks and Sewerage System •Structured as a separate legal entity (often a (MWSS), Manila, Philippines.” PPIAF case study. trust) that purchases shares held on behalf World Bank, Washington, D.C. Shares transfers are of the employees, with a defined mechanism Gates, Jeffrey R., and Jamal Saghir. 1995. “Employee best seen as an that describes how shares are distributed. addition to, rather Stock Ownership Plans (ESOPS): Objectives, than a substitute for, • Designed to take advantage of national tax Design Options and International Experience.” voluntary departure laws so that the plans are tax efficient both World Bank CES Discussion Paper Series 112. or early retirement Washington, D.C. compensation plans. for employees and for the companies. For example, the ESOP for Kenya Airways priva- Ray, Pranabesh. 2001. “HR Issues in Private tization was structured as a unit trust for tax Participation in Infrastructure: A Case Study of reasons (Megginson, privatization database). Orissa.” PPIAF case study. World Bank, Washington, D.C. • Established by the enterprise, which con- Valdez, Jose. 2002. “Case Studies on Human tributes either new shares of its own equity Resource Issues in Private Participation in into the ESOP or cash to buy existing Infrastructure in Bolivia.” PPIAF case study. World shares. Bank, Washington, D.C. Establishing a formal ESOP is relatively complex (see box 5.29) and requires independent profes- sional advice. Except in the case of employee or Web Sites Shares transfers are management employee buyouts of infrastructure not the best Capital Ownership Group: mechanism for units, ESOPS normally provide a level of owner- www.capitalownership.org/. (This is the site of a primary ship of 5 to 15 percent. Higher levels of ownership think tank on ownership issues funded by the Ford compensation to often entitle representation on the board, but this Foundation.) transferred workers may deter investors if they believe that further because of the risk European Industrial Relations Observatory Online: implicit in share labor adjustment is essential after PPI is settled. www.eiro.eurofound.ie/. (This site monitors various ownership.

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Shares are common Box 5.29: Checklist for Successful ESOPs incentives in f some form of ESOP is to be established, an important part of the communications privatization plans. here is a checklist of key issues that the process, particularly around the time that the implementing agency should ensure are being deal is completed.

I MODULE 5 followed. • In all of the concerns about the work force, it is Participation Issues important to ensure that management has •All employees should be able to participate, adequate incentives and that these arrange- subject to a qualifying length of service such ments are transparent. Often, an appropriate as 12 months. share option plan is one that allows employees to acquire additional shares when they achieve • There should be no great discrepancy between agreed targets, both corporate and individual, management’s stake and that of the rest of the over, say, a three-year period. work force. •Management also still has the right to manage. • There should be similar voting rights. Structural and Technical Issues • There should be similar dividend rights. • What is the source of the shares (existing gov- • Use of an employee trust aids flexibility and ernment shares, newly issued shares)? helps sustain the plan for the longer term. • What are the eligibility rules (how many shares •Transparency—particularly regarding the first to offer, when, and at what price)? allocation, where it is important that everyone knows broadly who is getting what. •What constitutes compliance with national leg- islation? •A “free share” allocation, even quite modest, is usually essential to get everyone in as a share- •Wages and conditions of employment should holder. be kept separate from share ownership. •Wages and other benefits (for example, pen- • Employee representatives (including trade sions) should not be sacrificed for a share unionists) should have access to independent scheme. professional advice about the plans. • It is usual for employees leaving or retiring to • It is important to build in features that will pro- have to sell their shares to the trust. mote the sustainability of the plan, such as leavers must sell their shares, use of trust. • The trust will be run by trustees and a bal- anced make-up of the trustees avoids its being • There is nothing wrong in principle with dominated by any one faction—for example, employees being asked to put their own two management representatives, two work money in—some employees will be more force representatives, and one independent focused on their jobs if they have their own trustee agreed on by the other trustees would money at risk. strike a good balance. • For distribution of shares it is best to use tax- Management Issues efficient share plans where available. •The engagement of a specialist adviser, famil- • Internal market: some of the work force will iar with ESOPs, trust law, and taxation, will be want to buy or sell some shares, and this is essential. usually allowed in private companies, on a “matched” basis when the scheme has been •A participative style of management is adopted running for a while. to make the best of the plan. •Depending on the size of the stake the • Communicating with the work force before, employees have, they may be entitled to look during, and after the plan has been implement- at having a representative on the company’s ed is vital to gaining their initial and ongoing main board—as a rule of thumb, a holding in support, thereby creating the necessary long- excess of 25 percent? term enthusiasm. • If the ESOP is put in place before PPI, should • Plans should be subject to full consultation the ESOP offer existing employees the possi- with the work force. bility to cash in at the time of privatization or • There is a need for culture change on both should it be structured as a long-term, per- sides (that is, management and the work formance-related incentive plan for the force), but it should be led by management. employees who best respond to the transition • Employees need to understand the difference to private management? (The answer is proba- between their rights and duties as employees bly both, and this will have implications for and their more limited rights as shareholders— how the ESOP is eventually put in place.)

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aspects of labor relations in Europe, including Privatization as Financial Means to Political and information on share ownership.) Economic Ends.” Journal of Financial Economics 53(2):217–53. National Center for Employee Ownership: www.nceo.org May, Karen. 1998. “Conversion to Worker-Owned or Cooperative Businesses through Privatization: Ohio Employee Ownership Center: International Experience and the Case of Puerto http://dept.kent.edu/oeoc/AbouttheOEOC/ Rico.” Available at cog.kent.edu/lib/May.htm. AboutTheOEOC.htm. (This center, based at a uni- versity in the United States, has an international program.)

Rapid Response: http://rru.worldbank.org. (This site is a gateway to a range of information on infra- MODULE 5 structure, privatization, and private sector develop- ment policies.)

William Megginson. http://faculty-staff.ou.edu/ M/William.L.Megginson-1/ (This home page for Professor Megginson has a number of papers on privatization to download, as well as databases giv- ing information on shares offered to employees in initial privatization public offerings, and longitudi- nal measures of share ownership in privatized enterprises worldwide.)

Other Material and Sources Binns, David. No date. “Privatization through Employee Ownership: Learned From the International Experience.” Available at cog.kent.edu/lib/Binns%20-%20Privatization %20Through%20Employee%20Ownership.htm.

Brzica, Dane. No date. “Privatization in Slovakia: The Role of Employee and Management Participation.” International Labour Organisation Working Paper IPPRED-12. Geneva. Available at http://www.ilo.org/public/english/employment/ent/p apers/ippred12.htm.

Cliento, Marco. 1998. Practice and Models of Financial Participation of Employees in the Companies of Europe: A Comparative Analysis. Rome: Institute of the Study of Innovation and Changes in Production Processes and Labour (SINDNOVA). An ESOP eases employee share Degeorge, Francois, Dirk Jenter, Alberto Moel, and ownership. A Peter Tufano. 2000. “Selling Company Shares to common model is a Reluctant Employees: France Telecom’s trust with well- Experience.” Working Paper 7683. Cambridge, defined rules on Mass.: National Bureau of Economic Research. share distribution, transfer, and Available at http://papers.nber.org/papers/W7683. buyback. Jones, Steven L., William L. Megginson, Robert C. Nash, and Jeffrey M. Netter. 1999. “Share Issue

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