Pay for Performance in the Public Sector—Benefits and (Hidden) Costs

Current reforms in the public sector are characterized by the introduction of businesslike incentive structures, in particular the introduction of ‘‘pay for performance’’ schemes in public institutions. However, the public sector has some specific characteristics, which might restrict the naive adoption of pay for performance. Our article analyzes whether the impact of pay for performance on performance is bound to conditions, and if this is the case, under which conditions pay for performance has a positive or a negative effect on performance. We explore this contingency in a meta-analytic review of previous experimental studies on the effects of pay for performance on performance. We further show why pay for performance sometimes negatively affects personal efforts. With an experimental vignette study we demonstrate (a) that motivation is likely to be a key influence on the effect of performance-related pay on performance, and (b) that pay for performance is generally more costly as it appears because it almost always produces hidden costs of rewards. Our findings help to explain the modest success of pay for performance in the public sector. There is a long-standing belief that the public sector and nonprofits need to be more businesslike in their attitudes and operations (Dart 2004). As a consequence, current reforms in the public sector are characterized by the introduction of management practices and techniques originally developed for the business sector, for example, budgeting techniques, market analysis, and performance management (Lane 1997; Moynihan 2006). One of the most significant challenges is the introduction of businesslike incentive structures, in particular the introduction of ‘‘pay for performance’’ schemes in public institutions (Varone and Giauque 2001; Swiss 2005; Cardona 2006). Two-thirds of the member countries of the Organisation for Economic Co-operation and Development (OECD) and a number of developing countries have adopted performance-related pay practices, for example, Brazil, We would like to thank Pascale Strub, Thorsten Teichert, and the participants of Menschen und Institutionen (HUI) and International Society for New Institutional Economics (ISNIE) for their helpful remarks, as well as Eve Weiss and Harmonie Sauer for their help in finishing our article. Address correspondence to the author at [email protected]. doi:10.1093/jopart/mup009 a The Author 2009. Published by Oxford University Press on behalf of the Journal of Public Administration Research and Theory, Inc. All rights reserved. For permissions, please e-mail: [email protected] Journal of Public Administration Research and Theory Advance Access published May 27, 2009