Explaining NGO-State Wage Differentials in Afghanistan: Empirical Findings and New Theoretical Models with Policy Implications in General Equilibrium

In this paper we present some novel findings on wage differentials between state and NGO (Non Government Organization) employees in Afghanistan. We find that high wages offered by NGOs, as high as 35 times those offered to civil servants, have strong distortionary effects on the local labor market and threaten the future fiscal sustainability of the state within a partial equilibrium setting. To complete the argument at a theoretical level, we also present a general equilibrium model with multiple equilibria that captures the deeper implications of the empirical finding. Among the most significant features of the model is the fact that the wage-gap feature can become permanent and lock the economy in a suboptimal social equilibrium. In light of our empirical finding and theoretical model consistent with the empirics we ask what the appropriate policy measures are. We consider, short of the extreme and implausible case of shutting down the state sector, three recommendations to address the issue and assess the strengths and weaknesses of each. Firstly, the host country could cap NGO wages. This, however, may be the hardest for the NGOs to adhere to given their internal salary scale policies and the need to maintain horizontal and vertical equity. Alternatively, government wages could be raised by a factor to arrive at a less distortionary gap. This would require substantial financial resources, which lie beyond the capacity of the state and the aid community. Thirdly, the NGOs could make contributions proportional to the size of the wage gap to a stabilization fund, earmarked to support future wages and redress current distortions. We argue that this qualifies as the most desirable policy choice given the conditions on the ground