As we anticipate the Chief Executive's Policy Address this month, and the Financial Secretary's 2003-04 budget just down the road, we will be hearing from a myriad of commentators about the difficulties of reducing the bulk of the government's spending -- civil service salaries -- and the need of both to increase spending on projects that enhance Hong Kong's competitive position and to raise revenues.

While there are a number of areas where the government's budget might be better spent, the emphasis on increasing revenues to deal with our rapidly expanding budget deficit seems misplaced. It may be difficult to reduce spending, but that is not sufficient reason to belittle the notion.

According to National Accounts statistics, compensation of employees comprises 82 per cent of total government consumption expenditure. Since reunification, the inflation rate of private consumption has been a cumulative -12 per cent, while that for government consumption was just -0.8 per cent. Clearly, any meaningful improvement in the SAR's fiscal position must take a hard look at civil service compensation.

But, it won't be easy. Article 100 of the Basic Law states: "Public servants serving in all Hong Kong Government departments, ... before the establishment of the Hong Kong Special Administrative Region, may all remain in employment and retain their seniority with pay, allowances, benefits and conditions of service no less favourable than before." Article 103 goes on to guarantee continuity in hiring, discipline, pay and conditions of service.

What is needed now is a joint executive, legislative and civil service unions approach to bringing Hong Kong back to fiscal health. None of the three can do it alone.

The annual Pay Trend Survey -- a comparison of private and public sector salaries at various levels -- guides salary negotiations between the government and the civil service unions. Other considerations include the state of the economy, the budget, the cost of living and staff morale.

In the last two years, the survey recommended first an increase (of 2.95 per cent to 6.15 per cent, depending on the level of pay) and in the second year a decrease of between 3.39 per cent and 0.6 per cent. When deflation is taken into consideration, real adjustments suggested by the survey were for increases in both years for lower- and middle-ranking government employees. At the upper level (civil servants earning more than HK$47,590 a month), the survey would have increased compensation -- in real terms -- by 9.2 per cent the first year, then reduced pay 1.6 per cent in the second.

What the survey doesn't take into consideration is that during this time the private sector restructured, reducing head count, offering early retirement packages and cutting annual bonuses. No such exercise has been under taken by the government: no departments were closed, no job functions moved to Mumbai and no real long-term cost-cutting put in place.

To get back on the road to fiscal health, the first and most immediate issue is for the civil service to accept a reduction in pay and a reduction in total staffing. Second, and no less important than reducing spending, is for civil service compensation to be more flexibly adjusted, based on performance. Most bureaucrats expect an annual increment for time served in a particular pay grade, regardless of performance. Perhaps in the initial phase of reform, the pool of money in each department and bureau that goes into these incremental increases should be allocated according to merit.

Clearly, what is needed is greater flexibility -- within depart-ments, bureaux and even teams -- to reward more generously those who out-perform, and to send a clear financial message to those who do not. It isn't easy, but it is a basic -- and proven -- management skill.