How Wage Hikes Shape Inflation in Mongolia: Insights from IMF’s Latest Study

The IMF study analyzes the impact of public and private sector wage increases on inflation in Mongolia, revealing that private wages drive inflation more immediately, while public wage hikes have a delayed effect. It recommends aligning public wage growth with productivity to prevent inflationary pressures and ensure economic stability.

The IMF Working Paper by Tigran Poghosyan, published under the International Monetary Fund (IMF), delves into the relationship between public and private sector wages and their impact on inflation in Mongolia. Conducted with support from the World Bank Office in Mongolia, the Ministry of Finance of Mongolia, and the Bank of Mongolia, the study is particularly relevant given the 30-40% public wage hike in 2023, which raised concerns about inflationary spillovers. Using quarterly data from 2000Q4 to 2023Q4, the study employs a structural vector autoregression (SVAR) model to explore how public wage policies affect inflation and private sector wage trends.

Mongolia's transition to a market-driven economy has resulted in stark differences in wage-setting mechanisms. Public sector wages are determined centrally, influenced by government budgets and political cycles, while private sector wages are market-driven and flexible. Over time, both public and private sector wages have outpaced labor productivity, fueling inflationary pressures. The research finds that private-sector wage shocks have a more immediate and stronger impact on inflation, peaking within four quarters, while public-sector wage shocks have a delayed impact, peaking between six and nine quarters. Both wage shocks exhibit an elasticity of 0.6, meaning a 10% wage hike results in a 6% increase in inflation.

Public vs. Private Sector: Who Leads Wage Growth?

A key finding of the study is that the private sector leads wage-setting trends, with public sector wages adjusting in response. Private sector wage increases significantly influence public wages, but the reverse effect is small and short-lived. This suggests that public wage growth is largely reactive, adjusting to maintain competitiveness with the private sector.

Sectoral data reveals that mining pays the highest wages, despite employing only 5% of the workforce, whereas agriculture employs 25% but offers the third-lowest salaries. The private wage premium, where private wages exceeded public wages, had been a persistent trend since 2011, mainly due to foreign direct investment (FDI) in the mining sector. However, the 2023 public wage hike eliminated this 30% premium within two quarters, bringing public and private wages to similar levels.

Historically, wage growth has fluctuated sharply, often influenced by political and economic cycles, while inflation has remained less volatile, suggesting that inflationary pressures are more persistent than wage shocks. This highlights the risks of politically driven wage policies, which can lead to long-term economic instability.

The Inflationary Impact of the 2023 Public Wage Hike

The 2023 supplementary budget serves as a case study on the impact of large public wage increases on inflation. The 35% average wage increase was 20 percentage points higher than Mongolia’s historical 15% average public wage growth rate. The study estimates that this wage shock will drive inflation 13 percentage points higher by mid-2025, before gradually subsiding by 2026.

Despite Mongolia's heavy reliance on imports, the Bank of Mongolia’s foreign exchange interventions have helped prevent exchange rate fluctuations from amplifying inflationary pressures. This indicates that the primary driver of inflation following public wage hikes is domestic demand growth, rather than external factors like currency depreciation.

Policy Recommendations: Controlling Wage-Driven Inflation

To mitigate inflationary risks, the government must align public wage increases with productivity growth rather than granting large discretionary hikes. Wage increases should be moderate, gradual, and based on economic fundamentals, rather than influenced by election cycles or temporary revenue windfalls.

The study suggests that instead of focusing on short-term wage increases, the government should invest in productivity-enhancing measures, such as education, skills development, and infrastructure improvements. The recent initiative to introduce performance-based compensation for civil servants is a step in the right direction and should be effectively implemented.

Additionally, excessive wage hikes can lead to wage-productivity gaps, which take years to close. To ensure stable wage growth, Mongolia needs a predictable and rule-based public wage-setting framework. This would reduce macroeconomic volatility and enhance monetary policy effectiveness.

Balancing Growth and Stability

Mongolia’s wage inflation dynamics reflect broader trends seen in emerging markets, where government wage policies play a significant macroeconomic role. This study contributes to the global understanding of wage-inflation interactions, offering a framework that can be applied to similar economies.

Policymakers must recognize that large discretionary wage hikes, such as the one in 2023, pose serious inflationary risks. Instead, Mongolia should focus on long-term structural economic reforms that ensure wage growth is sustainable and balanced with productivity improvements. Future research could explore sector-specific productivity trends, labor market flexibility, and gender wage disparities to refine policy recommendations and support Mongolia’s evolving economy.

By striking the right balance between wage growth and economic stability, Mongolia can protect its economy from inflationary pressures, ensuring sustainable development while maintaining macroeconomic stability.