​From the beginning of the 1970s until the recent round of negotiations in 1993, the process of wage determination in Israel's public sector underwent two major changes:

(a) There was a gradual shift from centrally determined uniform wage increases in collective agreements with professional unions to independently negotiated increases in each agreement.

(b) Policies involving strict wage restraint were introduced by the collective agreements. These changes in the process of wage determination affected the structure of wages in Israel's public sector in two distinct ways: First, there was greater differentiation between the basic wages of professional groups as determined by the collective agreements. Second, in response to small wage increases from collective agreements which would have led to a considerable erosion of real wages, the determination of wages at lower levels of negotiations increased in importance. At these levels, mechanisms meant to circumvent the restraint imposed by the collective agreements expanded rapidly. The main mechanisms were wage supplements paid to particular groups of employees or individuals, and accelerated promotion. These mechanisms soon became as important as the collective agreements in determining public sector wages. Low-level and less formal negotiations increased wage dispersion among different professions, and between employees performing similar tasks within each profession. Initially, the increase in dispersion might have contributed to a more flexible wage structure, through greater responsiveness to market forces as well as to individual motivation and performance. These mechanisms gradually lost their advantage as an instrument for rewarding a few employees at a low cost, and spread indiscriminately among more employees with rising outlays. More important, wage differentials grew until they were no longer functional and even became detrimental to labor relations and output.

The paper describes the growth of the mechanisms which partly replaced collective agreements in determining wages, quantifies their effect on the growth of total wages and wage dispersion, and attempts to assess the damage caused to the public sector by these mechanisms, and by excessive dispersion, in particular. Underlying the analysis of wage dispersion is an ad hoc model of wage determination in the public sector which focuses on the concept of an internal labor market and the negative relation between centralized wage determination and dispersion.

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