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Making Performance Pay More Successful in Public Sector


Ulas MOĞULTAY(*)

Abstract

Pay-for-performance has become a widely utilized means of improving productivity and decreasing costs in the public sector.  That, at least, has been the hope and expectation of governments around the world.  This paper examines pay-for-performance schemes in the public sector.  It uses examples of the experience of different nations around the world to illustrate the success and failures of pay-for-performance in the public sector.  It offers recommendations for instituting a successful pay-for-performance scheme, and concludes with the observation that even planning but choosing not to implement such a scheme can have a positive impact on a nation’s civil service.

I. Introduction

Starting in the 1980s governments around the world have tried to address a basic issue about government service, which is how to make that service more productive and more cost-effective.  Governments were being forced to respond to what was termed “the fiscal crisis of the State,” that is that government was costing taxpayers more and more, and the demands being placed on taxpayers were becoming unsustainable (Cardona 2002).  Even though the ability of taxpayers to finance government services was reaching its limit, however, does not mean that demand for services was declining.  Demand remained as high, or even increased.  The question faced by governments world wide was how to address these twin issues of high demand and high cost for government services. The answer seemed to lie in the area of increasing the productivity of government service workers – to gain more output from them for the same monetary input.  The subsequent question became, of course, how to achieve this goal.

To attempt to answer the question of how to increase productivity in the public sector, many countries turned to the private sector in search of a model.  One possibility, which seemed in many ways intuitive, was to fundamentally alter the ways in which the pay for government workers was disbursed.  Specifically, many governments instituted some form of pay-for-performance scheme for government workers.  Also called merit pay or performance-based pay, such schemes tie an employee’s base pay or bonuses to their productivity on the job.  Such schemes are widely used in the private sector and were seen by many as a route to improving the cost effectiveness of the delivery of government services.
The purpose of this paper is to review merit pay systems in government service from various nations in an attempt to determine their effectiveness compared to other systems of reimbursement for government employees.  The benefits and liabilities of such pay schemes compared to more traditional pay schemes will be examined.  Finally a recommendation will be offered for a system of merit pay that will allow governments to utilize such a pay scheme to improve the cost-effectiveness of the delivery of government services.

II. Traditional Payment Structures for Government Service

The typical, or traditional, system of pay in the governmental sector has been a system of grades and seniority.  Civil service sector pay has been graduated in the sense that different positions are assigned different grades or levels or some other designation that differentiates base pay based on the perceived value or difficulty involved in fulfilling the demands of that position.  A clerk/typist or a janitor position, for example, would generally have a lower grade assigned to it than would the position of a senior administrator.

Once installed in a position in government service a worker would then be compensated in terms of seniority.  This system of compensation, the use of service incremental salary scales, more or less guaranteed government workers wage increases at specified times during their tenure in their position.  Often such raises were annual, and were automatic based on seniority.  Further, workers in the public sector in many countries were (and remain) hard to terminate from a position regardless of performance. This has led to “public perceptions of civil servants as under-worked and overpaid.” (OECD in a Policy Brief May 2005)

There are advantages and disadvantages to the service incremental salary scale model of civil service compensation.  Linking pay increases to length of service helps keep workers on the job and reduces turnover.  This can lead to savings in training costs for new hires and allows the staff time to learn and become expert at what they do.  A major disadvantage is that there is often no link at all between pay and performance, allowing incompetent or lazy civil servants to get the same raises as productive and energetic workers.  Since the notion of equity is often seen as an important element in employee motivation, this can easily lead to a perception of inequity of treatment and a decline in overall morale and motivation within agencies that use such a compensation model.

Certainly the guaranteed annual raise and lack of focus on the performance of individual workers have contributed to the perception that civil servants are under-worked and overpaid, and the idea that government service guarantees a life tenure in a position has made civil servants appear to be unresponsive to the needs of the taxpayers who ultimately pay their salaries.  It often seems that public sector employees are paid merely for showing up at work.  The World Bank has for almost three decades recognized the problems caused by the traditional model of civil service pay structures, which it sees as central to what it terms “bureaucratic dysfunction” (1999).

This suggests another disadvantage to the traditional service incremental model of compensation.  Such a model leads to managerial inflexibility, or at least lack of flexibility.  Managers are unable to reward strong performers more than weak performers if raises are automatic based on length of service.  The only way to reward top performers is through promotion in grade, which generally means they are transferred to another set of tasks.  Therefore those who are doing a strong job at an important set of tasks can only be rewarded by removing them from those tasks and, therefore, assigning someone new to those tasks, which is not necessarily the intent of the manager.

The typical service incremental wage structure contributes, in the view of the Bank, to “endemic overstaffing and unsustainable wage bills” for governments. Spearheading an effort to reform civil service in developing countries, the World Bank began tying bureaucratic performance into its reviews of fiscal performance by developing countries in assessing governments as borrowers.  In other words the message being sent by the World Bank starting in the early 1980s was that unlike developed countries, developing countries could not afford a non-cost-effective civil service.
During the same period, however, many developed countries were arriving at the same conclusion without pressure from the World Bank.  As the OECD points out, starting in the 1980s Canada, Denmark, the Netherlands, Spain, the U. K. and the U.S. began instituting pay-for-performance salary plans in at least some parts of the government sector, with other developed countries following by the 1990s.

Pay-for-performance, or merit pay, therefore, has become seen as an alternative to the traditional structure of salaries within the governmental sector.  It is an alternative that has become perceived as a method of improving performance and ending bureaucratic dysfunction within government agencies and as a means to gain relief for taxpayers from the burden of supporting non-performing governmental services while still providing those services.  It is important, therefore, to understand exactly what pay-for-performance is, what benefits it offers, what drawbacks it might include, and how it is performing where it has been implemented around the world, in developing as well as developed countries.

III. Pay-for-Performance Schemes

A. What Is Pay-for-Performance?

There are a wide variety of different types of pay-for-performance schemes that have been implemented in both the public and private sectors.  These schemes have been used individually, in combinations, and combined with more traditional salary schemes. What all pay-for-performance schemes share in common are two basic ideas.  The first idea is that financial rewards are a key motivator in employee performance.  The second idea is that tying financial rewards to measurable work output will therefore increase employee productivity because employees will behave in ways that maximize their earnings.  The following are some of the common types of pay-for-performance schemes that are available to organizations in the public and private sectors.

B. Types of Pay-for-Performance

Piecework is the oldest form of pay-for-performance, having started in the early days of manufacturing.  Workers are paid for the number of finished products that they turn out during a defined pay period.  The Employers’ Organization for Local Government notes that piecework is still used as a pay-for-performance scheme in governmental direct service organizations (2006).  An example of how piecework might be used to determine pay is that an employee in a bureau whose activity was issuing licenses might be paid a bonus based on how many licenses he or she actually issued. Many people believe that police in many communities are rewarded based on how many tickets they issue to drivers for moving or parking offenses.

Estonia is an example of a country whose civil service remuneration strategy has elements of piecework involved.  After achieving independence from Russia in 1991 Estonia found itself in an unusual and difficult situation.  It had no tradition of a civil service in the Western sense, only a legacy of unaccountable ministries from Communist rule.  Yet in attempting to create a civil service in the Western model it found that the very countries it was trying to imitate were questioning their own approach to civil service.  In the late 1990s the Estonian government instituted a pay-for-performance component in its civil service remuneration scheme.  Under the plan government agencies could apply pay-for-performance funds by developing annual plans that fit within the framework of overall government action plans vis-à-vis those agencies.  Funds were then made available on a group basis to reward achieving the goals set in the action plans.  Many agencies adopted goals measurable in terms of units of work achieved.

Payment by results is another common form of pay-for performance reimbursement.  In such a scheme individuals or groups are paid bonuses based on achieving measured qualities or values outputs within specific time periods.  On a larger scale this type of scheme is called an organization-wide incentives system.

Such a system can include disincentives as well.  Hungary, for example, not only pays for results but penalizes for lack or results.  In 2001 Hungary enacted a law calling for the assessment of all full-time civil servants.  There are three layers to the assessment. On the top layer is a definition of the goals of each unit of the civil service, set by ministers and heads of public service bodies.  The next layer is a definition of personal criteria.  That is, each civil servant is given objectives within the framework established by the first layer for the unit in which he or she works.  The final layer is a written evaluation of each individual by his or her supervisor.  That is, this is an assessment of how that individual performed against the objectives.  The civil servant then may have his or her pay increased or decreased within a range of +30% to –20% based on the evaluation (Sigma Update, May 2005).

Merit pay, which is often seen as being a synonym for pay-for-performance, can also be seen as an early form of such a scheme.  Merit pay can be defined as pay, bonuses, or raises being based on an evaluation of the employee by superiors.  A tighter and more structured form of merit pay is called individual performance related pay (IPRP).  In an IPRP scheme pay, raises, or bonuses are awarded based on an employee’s performance against previously set objectives as reviewed using a formal performance management system.  The difference from merit pay is that such a system has more precise definitions of performance and more clearly stated objectives and a more formal rating scale.  An IPRP can also be used on a group basis.  That is, an entire office staff can be measured against pre-set objectives, with pay, bonuses, or raises based on the performance of the office as a whole.  The Hungarian scheme can be seen as falling into this category as well.  From the point of view of the Hungarian government their program has been successful in tending toward the creation of a more efficient and professional and motivated civil service and the central tenet of the system is rigorous evaluation of individuals by supervisors (Sigma Update, May 2005).

South Korea, as well, uses an IPRP.  South Korea is seen by many as a major success story in the utilization of pay-for-performance in the public sector.  The keys to South Korea’s success are seen as four elements: increased managerial autonomy and skills; reliable and timely information; adequate skills to supervise and evaluate workers based on solid criteria; and political will.  While there are ways to build up and compensate for lacks in the first three elements, there is no substitute for the fourth element (Shirley 1989).

Spain is another example of a country that based civil service reform on the institution of an IPRP.  Spain introduced pay-for-performance in the public sector in the 1980s.  Spain uses a “collective” performance incentive system, a group IPRP, called the ‘productivity complement,’ which represents up to one-quarter of the individual civil servant’s salary each year.  Each fiscal year the Ministry of Finance sets the productivity complement for each government agency, and goals are established for all management centers.  Departments are evaluated on a group basis, with only unit heads evaluated as individuals.  As an example of the success achieved, there is improvement gained in the Spanish social security system, where claims once took six months to process but now average seven days (Breul 2005).

Uganda in the 1980s and 1990s started serious efforts to improve civil service performance.  A major initiative was a change in remuneration policy. Previously Ugandan civil servants, except at the highest levels, were poorly paid, a situation contributing to endemic corruption.  The civil service system was also a major patronage area in Uganda, and appointments, raises, and promotions were based largely on political connections, and not on performance.  In an effort to improve civil service performance Uganda in the 1980s raised basic pay and instituted performance measures in its remuneration package.  In the 1990s Uganda began structuring an IPRP, and the results, as observed by the World Bank and others have been a great increase in effectiveness and professionalism in the Ugandan civil service (Lienert, 1998).
Commission and profit-related pay schemes are generally only applicable to private sector organizations, where they have long been used. 

Commission gives the employee some percentage of the revenue he or she generates.  Profit-related pay bases salary, raises, or bonuses on the contribution of the employee to the profitability of the organization.  Since, with few exceptions, public sector organizations are not oriented toward, or even intended to be, profit making, such schemes are of little application in this sector.

In some ways these last two pay-for-performance schemes are far and away the easiest to administer, since the amount of individual sales or the profitability of an individual location are relatively easy to determine.  In a sense, then, one drawback to pay-for-performance in the public sector is that in the absence of profit as the bottom line measure, it is often difficult to establish valid measuring systems.

C. The Advantages of Pay-for-Performance in the Public Sector

The main perceived advantage of a pay-for-performance scheme in the public sector is that some form of performance-based remuneration will increase productivity and cost-effectiveness.  That is, that a pay-for-performance scheme will result in better performance by employees.  Further, it is believed, such schemes will allow managers to weed out less effective employees, or at least reward them less than their more effective and productive counterparts.  The OECD notes that part of the attraction here, for governments, is that a system of performance-based bonuses that are not part of the actual salary structure can help eliminate the system of scheduled raises and allow actual remuneration to be high while not impacting the pension burden of the organization.

Another positive effect of the ability to increase pay for top employers will, again at least in theory, make public sector employment attractive as against private sector employment.  The current perception is that the ‘best’ people go into the private sector, in general, and that the reason for this is the opportunity for higher salaries and bonuses (OECD Policy Brief, May 2005).

The political dimension also makes pay-for-performance attractive in the public sector.  As already mentioned, there is a widespread perception of public sector employees being overpaid, under-worked, and (since many, perhaps most, are tenured in some way) unaccountable.  The institution of pay-for-performance schemes allows governments to state that in fact public sector employees are now being paid for the work that they do, not the time they spend on the job, and are rewarded strictly in terms of how they perform on the job (Policy Brief, May 2005).

It is pointed out that pay-for-performance schemes also contribute to overall accountability within the public sector. By delineating exactly what is expected by agencies and the managers and workers within those agencies, government ministers and the general public can now have a clearer picture of who is responsible for good or poor performance within the civil service (Lienert, 1998).

Finally, an important advantage in pay-for-performance schemes is that it makes managers examine carefully what exactly it is that they want employees to achieve. That is, it causes agencies and organizations to carefully assess what are the actual desired outputs they are seeking. This helps managers to be able to focus on what is central to their operation, and become familiar with how the parts of an organization ought to operate in order to excel.  Again, managers can hold their employees accountable for their performance, and be held accountable themselves, in terms of how they measure up to standards that are established in accordance with a close examination of function.

D. Disadvantages of Pay-for-Performance in the Public Sector

There are several disadvantages to instituting a pay-for-performance scheme in the public sector.  Even though pay-for-performance schemes in some form have been instituted by many, perhaps most, governments world wide, these disadvantages have long been recognized.

To begin with, at can be argued that there is a flaw in the major premise behind pay-for-performance schemes.  The underlying premise behind all such schemes is that workers are motivated primarily by monetary rewards and that an increase in remuneration based on performance will invariably lead to an improvement in performance along the lines desired by management.  Yet pay, per se, is not necessarily that potent a motivator among all workers.   In a survey of American workers both in public and private sector, for example, found that many workers were very concerned about their level of job security (LeBlanc and Mulvey 1998).  The implication here is that many workers might be more motivated by a system that rewarded performance with the promise of long term employment than by a system that emphasized short term bonuses. Ironically, of course, one of the chief attractions of the traditional model of government sector jobs was long term employment stability. Another drawback with pay-for-performance, as is demonstrated every year in contract talks between teachers and New York City, is that pay-for-performance systems tend to undercut unions.  Public service workers’ unions widely recognize this, and generally fight against the institution of pay-for-performance schemes.  While unions generally bargain to gain wage increases for members, the priorities of such unions generally appear to be in maintaining benefit levels and pension levels and retaining union involvement in any discipline or termination proceeding against union members.

While public sector unions tend not to be very popular with the general population, they do serve the valuable function of helping to keep civil service non-political.  Administrations on the local, state or regional, and national levels come and go. Civil servants remain, and unions tend to work to keep civil service removed from political interference.

Pay-for-performance schemes are dual-edged.  They give managers more flexibility to reward the best workers, but also provide systems to label the least effective workers, all against standards set by managers.  The potential exists for pay-for-performance to put civil service back into the days of total political patronage, where entire bureaucracies were emptied and workers replaced with loyalists to the party newly in charge.  Unions have tended to be a force against such patronage, and the undercutting of unions by pay-for-performance therefore threatens the professionalism of the civil service.

IV. Recommendation

There are clearly drawbacks to pay-for-performance schemes as instituted around the world, yet there are also success stories associated with implementing such schemes. Overall it is recommended that a carefully designed pay-for-performance scheme should be instituted by any country desiring to improve productivity in the public sector.  The key words here are “carefully designed,” and the following is a suggestion on the steps that might be taken to create a successful pay-for-performance reform of a civil service unit in any country.

The first decision to be made is choosing the type of pay-for-performance scheme is appropriate to the situation, agency, and national culture. American workers, for example, dislike group incentives and prefer individual incentive programs.  Workers in Asia and Central Europe appear to get satisfaction from group evaluation as well as individual evaluation.  Choosing the right scheme is important in achieving the desired levels of motivation.

It is also important to choose the appropriate locus of control, that is, deciding where goals and objectives should be set.  Funds can be allocated and objectives set at different levels within the public sector.  In Estonia agencies, for example, set their own goals in pursuit of funds available within a sort of general fund, and this was not a success, but in the US and other developed countries such schemes have worked well.  In Singapore goals are set at the highest levels, as they are also in Hungary. Germany is highly centralized in control, while New Zealand is very diffuse.  The national culture in many ways dictates the shape of the civil service, and the locus of control that is most appropriate largely depends on how the civil service in any state is organized.

Once funds for an IPRP or other pay-for-performance scheme are allocated, it then becomes important to set realistic and meaningful goals.  In Estonia agencies avoided the difficult and hid problems in their establishment of objectives.  Setting meaningful objectives requires a thorough investigation into the workings of the civil service unit in question and the asking of important questions.  The key question to be asked is “what do we really want this unit to achieve?”  That is, setting objectives requires insight into the real mission of the unit.

It is equally important for the goals to be concrete and measurable.  Too often pay-for-performance schemes in both the private and public sector use vague and subjective instruments, allowing managers to reward favorites and not reward employees they dislike, or duck the issue of performance entirely by acknowledging that all employees are performing satisfactorily.  A suitable instrument of measurement using concrete objectives is the best means of avoiding such results.

Also necessary is to establish appropriate incentives.  Those seeking to make civil service less of a fiscal burden on taxpayers (that is, ministers and top managers) prefer incentives to be non-recurring bonuses.  Workers prefer merit-based raises that remain a recurring part of their salaries (in general).  Hungary addresses this problem with its concept that salaries can decline if performance is considered as achieving less than expected results against criteria.

The training of managers well in how to evaluate workers based on their performance against established criteria is also crucial.  Many writers have noted that pay-for-performance schemes often fail because of a lack of management training in evaluation, and the use of inappropriate scales.  Pass/fail systems are too limited, while five rank scales are too complex.  The three rank scale is recommended as being least confusing and most meaningful – employees are ranked as either exceeding, meeting, or failing to meet expectations.

Once a pay-for-performance scheme is in place it is important for implementation to be consistent. All employees must be evaluated fairly, and at equal intervals.  Equity as well as remuneration is an important aspect of job satisfaction.  Workers must feel they are being equally treated, even if results of evaluations will not be equal.  Consistency all requires that whether the locus of control is central or diffuse that all agencies using incentive programs do so with a fairly equitable distribution of resources.

As with any initiative in any organization, follow-up is important.  This means it is necessary to constantly review and refine.  The Estonian experience reveals that importance of auditing pay-for-performance schemes.  They must be audited, preferably by an external auditor, both in terms of whether they are being administered as intended, and whether or not they are achieving desired results, or at least tending in the direction of improvement toward desired results.  As managers gain skill and comfort with evaluating, and top managers become more comfortable and skillful at setting objectives and goals, a process of constant review will lead to a continuing refinement of the pay-for-performance scheme and therefore, it is hoped, to a continuing improvement in the productivity of the civil service unit in question.

Finally, as multiple example make clear, civil service reform, as suggested by the experience of South Korea and Singapore, begins with political will.  It is essential to maintain that political will, to not lose sight of the benefits to be gained from a reformed and less fiscally burdensome civil service.  It must be understood from the start that instituting a successful pay-for-performance scheme in the public sector is not inexpensive or easy to achieve.  A good amount of time and money, for training as well as for incentive pay, must be allocated.  It will be tempting to give up the scheme as a lost cause.  Only a strong political will will enable a government to successfully reform civil service through implementation of a pay-for-performance system.

V. Conclusion

There is a wide range of types of pay-for-performance schemes that have been used in efforts to reform civil services around the world, and there have been a wide range out outcomes from these efforts.  Despite some notable successes, and some notable failures, the results generally have been inconclusive.  Certainly Estonia illustrates the downside of pay-for-performance extremely well.  Even in the face of this mixed and generally not positive performance world-wide, however, most governments have some sort of pay-for-performance scheme in place in parts, if not the entirety, of their civil service.  The reason is that pay-for-performance does hold promise.  If it is carefully designed and supported over the long term by strong political will, a pay-for-performance scheme appears to have the potential to make a civil service unit more productive and cost effective.

Further, the experience of Uganda and other Sub-Saharan African nations indicates that overall civil service fiscal outlay can decline using a well-designed pay-for-performance scheme.  Such reforms (Lienert 1998) can allow for the overall downsizing of the civil service.  In other words a pay-for-performance scheme can aid in getting the same amount of output (or even more) from fewer workers.  In the face of a world-wide perception that government is too costly for taxpayers to continue to finance, this is a major motivation for implementing pay-for-performance. Schiavo-Campo points out that this has been successfully the case in Uganda (1996).

There is, however, another reason to recommend implementing, or at least investigating, a pay-for-performance scheme in the public sector.  Even if a government studies such a program and decides not to implement it, there is a benefit.  The benefit is knowledge and insight.

To even contemplate instituting a pay-for-performance scheme requires top civil servants and government ministers to examine closely what outputs they desire from any given civil service unit, or office, or government agency.  Such an examination requires focusing on what the agency’s real mission is, what the workers in that agency have to do to accomplish that mission, and how that agency fits into the overall planning of the government.

Too often in organizations, in the private as well as public sector, the relationship between the individual, the department, and the whole becomes lost in a too-narrow focus on just one element.  Planning towards implementation of a pay-for-performance program, if that planning is well done, requires focus on all aspects of this set of relationships, and therefore offers insights into the way the parts work together to create desired ends.  In and of itself such an insight is a worthwhile output of planning a pay-for-performance implementation.

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(*) Consultant, World Bank