3 steps to payroll reform in post-conflict states

Payroll systems in many fragile and conflict affected states are working poorly or not at all. Here are all the important issues to consider for design and implementation.

For many good reasons, governments prioritise design and implementation of robust payroll mechanisms. Robust payroll systems are fundamental for credibility of a fragile and conflict affected state.

In this article, we discuss the pros and cons of payroll reform, and also show a technical roadmap for design and implementation of such reforms.

1. Unreliable payroll is a major problem in many fragile and conflict affected states

Public employers in fragile and conflict affected countries do not pay their staff reliably.

• Public sector workers may not be paid on time or they may be paid to little.
• Public sector staff may need to be creative about other income sources, i.e illicit fees, taxes and other abuses of the position in order to secure themselves an income. Corruption may increase and general rule of law weakened.
• The payroll registries may be loaded with ghost workers, eroding the effectiveness of public finances.
• Unreliable payroll does little to improve human capital. Motivation and commitment from staff is hard to mobilise. Capacity building and training institute efforts may be wasted.
• Broader sector development objectives are difficult to achieve when staff are fundamentally unmotivated.
• Lack of good information systems about public administration workers blocks meaningful policy and sector development. More often than not, are staff numbers inconsistent across the administrative systems. Implementing effective human capital strategies is difficult when the decision making information is poor.

What is taken for granted in most countries of the world, turns out to be a fundamental problem in fragile and conflict affected states.

2. Payroll reforms are winners

• Payroll reforms are popular. As opposed to other financial management reforms, payroll reforms make many people better off, immediately. The public sector workers that starts to receive their salaries regularly, quickly become supporters of the reform. This makes it difficult to reverse the reforms. Social accountability may be more effective than formal accountability in a fragile state.
• The benefits are widely distributed. Many families get regular income. Neighboorhoods and small businesses see visible pick-up in economic activity in and around payday.
• Payroll reforms are surprisingly manageable. They are centralised, as compared to many other parts of the financial management systems which are decentralised. The core processing and authorisation of payroll is managed by few. This makes design and implementation easier.
• Payroll is also easier to control and audit. Payroll processing is repetitive, controls and audits can be streamlined. Other parts of  than many other parts of public spending involve more unique transactions, more resource intensive to control.
• It´s a substantial expenditure area for most countries and a core focus of most public financial management (PFM) reforms.

3. Payroll reform design and implementation is challenging

Payroll mechanisms are frequently on the agenda for our clients. This may focus on civil service workers, teachers or health workers, and military or police personnel.

Despite the many benefits, success in payroll reform has proved to be challenging.

• Success requires much political alignment. There may be resistance, from the few who benefit from the misdirected public resources. It requires political statecraft and entrepreneurial reform champions to overcome this.
• There are coordination problems. Payroll reforms inevitably cut across institutions. Roles and responsibilities to manage the reform may be challenging to establish.
• Payroll reforms involve several sectors, the core treasury and financial management practises, as well as bank and payment systems. There are many actors and coordination problems arise.
• Level of authority to design and implement the reform may be a question. We have seen successful reforms but only after the President or Prime Minister got involved to push it through.
• Payroll reform involve complicated technologies. Information systems and administrative systems may need to be aligned and work together.
• Payroll reforms may be loaded with too many complex policy issues, effectively derailing success. Oftentimes, reforms also try to address related human resource management hrm issues. Reforms include revisions of human capital policies in general. Recruitment and selection, job descriptions, performance appraisals and other human resource issues are bundled. This takes much management capacity and focus. Management capacity is a scarce resource in fragile and conflict affected states.
• Reforms may have a single issue focus, i.e implement a new HRIS system, and not addressing the other core elements of robust payroll.

There are also a number of technical challenges. These relate to both the direction of the reform, its scope and its solutions. We discuss these in the following sections.

4. Three steps to design and implementation of payroll reform

This focuses on three key questions:

Step 1: How to scope the payroll reform?

Step 2: How to identify the key issues that must be resolved?

Step 3: How to design and implement the solutions?

The subsequent sections will discuss how teams can proceed through these issues: step-by-step

4.1 Step 1: Scope the payroll reform

Whether we start with a blank slate (rarely), or more common, are tasked to redesign an existing mechanism, it is useful to begin with a framework to structure the discussion. This helps to ensure all issues are covered.

It is also easier to manage if the complexity is broken into smaller and more manageable pieces.

A payroll mechanism can be described as having three main building blocks. Together, these building blocks constitute all the main functions. They are also logically distinct, which is helpful for organizing our thoughts.

Exhibit 1 Illustration of the key modules of a functioning payroll system

Scoping should consider:

1. Workforce management issues. How are staff registered in the information systems? and how is information about their status maintained.
2. Financial management and treasury operations issues. How do we authorize payments and account for the money?
3. Payment system issues. How are the payments delivered? You would be surprised of how many that are still paid in cash.

Payroll reform may not need to address the full scope of these issues.

• In many countries, parts of the system is working reasonably well. For example, the core financial management and treasury are often the strongest parts of a government. The challenges are often more related to workforce management.
• Many fragile and conflict affected countries also have a functioning private financial sector that can deliver payments across multiple channels.
• In particular difficult situations however, a full overall is needed.

There are two related reform areas for which it can be wise to postpone, or sequence reforms, subsequent to addressing the core payroll problems.

First, broader human resource management hrm issues can be dealt with subsequently. Reforms of recruitment and selection, job descriptions, accountability, performance appraisals and consequence management are all important. However, they involve more complex behavioural, cultural and institutional issues than payroll. Payroll reform has a relative technical focus, less cultural and political, which may be a good thing, in terms of improving the chances of success. One step-at-a time.

Second, clients often ask to include HR Audits and verification of workforce numbers. These are important issues to consider. However, in many situation it is more helpful to first fix the core system. Ensure that the personnel registries function properly. If not addressed first, any verification and HR audits of staff numbers will have a very short validity. The resources may be wasted if the core system cannot reliably handle and update the information. A well designed payroll mechanism will also be more effective in controlling at later stages.

4.2 Step 2: Identify the key difficulties that needs to be resolved for each segment of the payroll process

This section discusses typical key issues for each segment. The framework presented in the exhibits below, one for each segment, can be used as a map. Work through each of the elements on the charts. Are these issues that need to be fixed? Are they important enough, and is it feasible to resolve them within the scope of the reform.

In the real world, it is not common to address all the issues.

First, they may not all be a problem. In some country systems parts of human resources management may work well. It requires research and analytics to determine which is inside- and outside of scope. In problem solving methodologies this is called the “issue stage”. Identifying what needs to be addressed.

Second, hard prioritization is needed. This involves a candid assessment of what is important and feasible. For example, a client who was reforming security sector payroll, in a particularly politically and technically challenging environment, decided to have a very narrow scope. They focused narrowly on workforce registry administration. This was the bare minimum needed to deliver a functional payroll mechanism. The idea was that this would be more feasible to implement in a difficult environment.

We start with the first segment; on human resource management. This is illustrated in the exhibit.

4.2.1 Segment 1: Human Resource management

Fundamentally, workforce management is about managing staff entry (recruitment and selection, hiring and onboarding). It also involves staff development, and managing their exit. This can be broken into a number of sub-issues.

At the minimum, in a fragile and conflict affected state, addressing the workforce administration issues is required. This is about how personnel are included in the registry. Are their names recorded in the registry? Are the appropriate authorizations in place? Who has access to imputing names and making changes? How are changes authorized and documented? It will be very challenging to build a robust payroll if these issues are not sorted.

For example, when designing a payroll for security forces, a key issue was the alignment of different personnel registries. Some maintained by government, others by donors and international agencies. They did not match. In addition to this problem of stock, there was also a problem of the flow. The procedures for imputing new staff onto the registries were opaque, different form time-to-time, and also differed between all the registries.

Problems and solutions for workforce administration often involve technologies. Dedicated Human Resource Information Systems (HRIS) will help immensely in establishing more robust human resource registry management. However, software and hardware will not alone be sufficient. In fact, if work procedures and roles and responsibilities are not aligned with the technology, the new machinery may never even be turned on. It happens unfortunately.

It may be advisable to not overreach. While important for human resource management more broadly, it is not always possible to address recruitment and selection, hiring or training and development. These are important issues for the long term strengthening of sate capability. However, they do not need to function very well in the first instance to get a fledgling government up and running reasonably well.

Maintaining integrity of personnel registry information systems over time is challenging in fragile and conflict affected states. We would advise periodic audits and reviews, but only upon establishing a good functioning core process. The PEFA group recommends audits every other year for countries with major financial management challenges. HR audits are very expensive.

Exhibit 2 Illustration of the main issues of workforce management/HR in a fragile state government

4.2.2 Segment 2: Finance and treasury

Moving on to the key treasury and finance issues illustrated in the exhibit below.

The financial management process is an important part of the payroll. This starts with planning, budget and commitment issues.  This in itself involves a range of issues. At the minimum, a central level (i.e Ministry of Finance) managed budget, approval and commitment process is required. These issues are typically part of core government financial management practise, irrespective of the quality of personnel planning in a sector. As such, Ministries of Finance, in even the most fragile and conflict affected state, may be able to handle this reasonably well.

An advantage of payroll as compared to other expenditure areas, is that the commitments are predictable. Upon hiring a staff, a commitment is entered into. As such, most governments have a reasonably good idea of their outstanding payroll commitments at any time. This helps planning and cash rationing.

More sophisticated solutions would involve labour budgeting, short- and long term projections, aligned with sector development objectives and strategies. This may involve planning capacities in the sector ministries. Alignment with national expenditure frameworks, and processes for revisions, negotiations and approvals. This is important, but rarely urgent.

Next step is the spending authorization and cash management. This involves authorizations of the payments. Each pay-run, month-by-month should be authorized. It may need to be authorized at the sector ministry level, but also verified at the Ministry of Finance level.

The payment authority normally rests with the ministry of finance in a fragile and conflict affected state. Payment authority means the ultimate responsibility to release a payment. Decentralized payment authority often requires better functioning accountability and control mechanisms than are found in fragile and conflict affected states. The IMFs and the World Banks of this world will rarely allow a fragile government to decentralize its payment authority.

The exhibit below provides a breakdown of key issues. This can be used as a framework to identify relevant issues for a particular country or sector.

Exhibit 3 Illustration of the main issues for payroll management in a fragile state

4.2.3 Segment 3: Payment system

Lastly, we discuss issues of payment systems.

Some countries of the world have national financial infrastructure that seamlessly integrates government treasury, central bank and commercial payment systems. In fragile and conflict affected countries, there are often considerable private sector capabilities, but the integration between government, central bank and commercial financial institutions does not work.

For example, countries we have worked with have multiple payment channels developed. Salaries can be disbursed in cash, bank transfers or via other channels, i.e. deposit cards, money transfers or mobile money.

The challenge is typically not so much the lack of payment options, but more of lack of effective integration of them. There may not be function national clearing houses. There may not be efficient interfaces between the Central Bank and commercial banks. The Central bank cannot instruct commercial banks to make payments through other means than handwritten letters. “Electronic” payments systems turns out to often mean “excel and email”.

Financial institutions in fragile and conflict affected states typically have challenges with know your customer (KYC) implementation. This is important as they are ultimately the ones that are identifying whether the staff and the bank/mobile money accounts match up.

How are people identified? How can you be sure that the account numbers are those of the staff and not all belonging to the Minister?

In the worst case, financial institutions may be found incompliant with global anti-money-laundering and countering the financing of terrorism policies (AML/CFT). How do you ensure that personnel being paid are not on international sanctions and SDN lists? That can have a devastating impact on the financial system in a fragile and conflict affected state.

Exhibit 4 Illustration of the main issues for making payments to personell in a fragile state government

For teams responsible for design and implementation of a reform:

Take time to systematically research and analyse all the issues above.  Identify early on what is relevant and what is not. Document and understand the facts, communicate them to the relevant decision-makers, and understand the significance of the issue. This is time consuming and technically challenging, but important to get right so that the reform gets off on the right track.

4.3 Step 3. Develop the solutions to payroll management that are feasible and will have impact

By this time, after having completed the issue-analysis thoroughly, ideas about solutions usually surface. This phase of the problem solving focuses on identifying and prioritizing the solutions. We also aim to identify implementation arrangements, including estimates about timing and costs.

A useful starting point is to structure potential solutions along organizational “levers” or capability areas. These are the areas where we can practically impact the organization in order to change the behaviours of the people involved.

There are usually 3-5 plus one areas that are meaningful to address:

Legal and regulatory: Are there issues in laws and regulations that may need to change to allow for a new payroll mechanism? Are there guidelines needed?

Accountability arrangements: Who is responsible for the various aspects of the new payroll? Is there clarity on roles and responsibilities? Is there accountability if things go wrong?

People: Is there enough talent around? How is the supply of new talent assured? How are staff trained and developed?

Process: Who does what and in what sequence? Payrolls are transaction intensive and repetitive activity. Aim for clarity and simplicity, not efficiency. The key is to make the process work.

Information and technology: What are the supporting technologies? Are there several and if so how can we make them interact? How are the non-digital actions supported? Are there forms or lists?

Plus one: Managing the change. Critical, frequently ignored and under resourced. Especially in fragile states, the managerial capability of the institutions to manage change cannot be assumed.

Exhibit 5 Illustration of the main areas in which to build capacity in a payroll mechanism

Reformers also need to balance ambitions with feasibility. In other words, there is a need to prioritize. Many solutions will be out-of-scope in terms of costs or in terms of implementation viability. Also, and frequently overlooked when prioritizing, is the concept of time to maturity. Some issues will require much longer time to maturity and may not form part of the Reform 1.0 but may be relegated to Reform 2.0 or later.

While no formula exists in order to calculate the prioritization entirely, a few good decision tools can help to structure the process. For example, we frequently find ourselves reverting to two simple matrixes: An impact versus feasibility framework, and a risk and maturity framework.

Other frameworks can also be helpful. From this we may find that certain aspects of the reform will not be possible to mature over the short term. As such, we can develop a vision of reform horizons – where the functionality and sophistication will increase over time.

Finally, we’re all set for roll-out and implementation. Expect adjustments and iterations and don’t consider that a problem. Beyond anything, do not underestimate the managerial challenges involved in making real change happen.

Ivar Strand and Ian Hawley Managing Partners @ Abyrint.