Pay Reform in Public Administration: Moving Beyond Standard Advice

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Zahid Hasnain, Senior Public Sector Specialist (EASPR)

Outline of the Presentation

1. What is the “functional problem”?

2. Key theories and reform levers

3. Short term career incentives

4. Longer term career incentives

5. Pay reform options

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1. What’s the problem?

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In general, there are 3 problems that pay policy reform are seeking to mitigate:

1. Agency productivity:• Need to attract and retain high quality staff — competitive with the

labor market for all the key positions.

2. Individual effort: • Pay should be perceived to be fair and transparent — compensation

should be matched to the demands of the job and staff should be able to easily see this.

• Need to induce performance and accountability of staff to serve the public.

3. Public sector wide :• Need to do all of the above while ensuring that the overall wage bill

is fiscally sustainable and does not crowd out other expenditures.

Difficult to achieve all of these objectives as they may be mutually inconsistent 4

2. Key theories and reform levers

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What motivates people?

• Theories of motivation• Expectancy theory • Reinforcement theory • Microeconomic principal-agent model of labor

relations • Behavioral economics - distinction between

intrinsic and extrinsic motivation (are public service workers “knaves or knights”?) – LeGrand vs Pink

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What are the reform levers?

• External incentives • Longer term incentives: Promotion, steadily increasing pay

over a long career, and recognition from peers. • Short term incentives: Performance-related pay, non-

monetary recognition , and renewal of a fixed term contract.

• Opportunities to perform • The space for self-directed work, a key enhancement to

intrinsic motivation, and adequate resources including, for managers, reasonable confidence that they can obtain results via the staff that they direct:

• Both external incentives and opportunities to perform are important, particularly for managers.

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Long and short term incentives seek to address these differently• Long term career incentives are largely about intrinsic motivation

• The public sector attracts people who like stability/certainty/predictability • Respect and reputation are important parts of the long term reward structure;• As long as pay is adequate to recruit people who are attracted by public

service then (merit-based promotion providing the prospect of higher pay later in the career is an important part of the reward structure;

 

• Short term performance incentives focus on extrinsic motivation:• Performance rewards are ways of addressing the problems of moral hazard

and adverse selection• PRP however, can crowd out “intrinsic incentives” (“if you’re going to treat me

like a factory worker on piece rate, I’ll act like one”);• The big return from performance-based rewards might be over time – as staff

who work well under performance-based incentives are attracted into a public service that has it in place.

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The pay structures in developing countries can be seen as unstructured attempts to address at least some of the external incentive problems

• “Typical” country will have base pay plus a plethora of allowances and salary “top-ups” for “key” staff

• Why does this structure exist?

• Allowances and top-ups are needed to attract and retain certain categories of staff

• Decompression of pay is generally not politically possible and increases in pay for all staff will blow the budget

• The pay system is non-transparent; but that is at some level the whole point because a transparent system would make it politically more difficult to have pay that varies by categories of staff

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Indonesia is typical in many ways

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Example: Monetary compensation in selected agencies (excluding honoraria and in-kind benefits)

WB standard advice of merging allowances into basic pay has not worked

• We usually see these allowances re-emerge over time

• The main reason is that it does not solve the underlying problems, given the political constraints

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3. Short term incentives

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OECD countries have moved towards short term incentives to try solve the 4 problems

• Realization that a uniform pay spine across the civil service was not meeting the objectives.

• Starting in late 1980s, several OECD countries moved to pay flexibility in the civil service:

• Differentiation: The same job can pay differently across agencies and geographical locations

• Individualization, or performance-related pay: Two individuals in the same agency in the same job get paid differently based on performance

• Delegation: Decisions on pay are transferred from central civil service agency to line ministry/agency which presumably has better information about staff

• This mirrored developments in the private sector in the 60s and 70s.

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Performance-related pay is now on the agenda: What is the international experience?

• Many OECD countries, and some MICs (e.g. Thailand, Brazil) have introduced PRP for core civil servants and service delivery staff.

• Opinion is highly divided on whether or not performance pay works.

• (Hasnain, Manning, and Pierskalla, 2012) recently completed a review of the literature on performance related pay:

• 110 studies reviewed

• Disaggregated findings by (a) quality of the empirical study; (b) the different types of public sector jobs; and (c) geographical context (OECD or developing country)

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The theory behind PRP• Largely focuses on individual incentive effects: Addressing

problems of moral hazard and adverse selection

• Impact on staff effort

• Impact on sorting: Higher quality staff who are likely to do better under PRP self-select into the agency

• Counter argument: when tasks are multi-dimensional incentivizing only some tasks that are observable and measurable will lead to a substitution of effort allocation from the unobservable to the observable tasks (“teaching to the test”)

• Behavioral economics also warns that PRP may crowd out intrinsic motivation

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Findings disaggregated by job type usingJames Q. Wilson’s typology

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1

15

33

19

8

24

60

5

0

10

20

30

40

50

60

70

Prod. Job Craft Job Coping Job

Num

ber o

f stu

dies

Findings by job type

Failed Neutral Positive

Findings by job type and country context

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17

1

24

3

46

19

05

101520253035404550

OECD Developing Country

Relevant studies (craft or coping job) by country context

Failed Neutral Positive

Findings by job type and quality of study

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Findings by job type and quality of study

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12

0

10

0

44

2

0

5

10

15

20

25

30

35

40

45

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Craft Job Coping Job

Findings for high quality (4 and 5) relevent studies only

Failed Neutral Positive

To summarize• Evidence suggests that explicit performance standards linked to

some form of bonus pay can improve, at times dramatically, desired service outcomes.

• More rigorous studies are overwhelmingly for jobs where the outputs or outcomes are more readily observable, such as teaching, health care, and revenue collection.

• Insufficient evidence, positive or negative, of the effect of performance-related pay in organizational contexts that that are similar to that of the core civil service.

• Insufficient evidence in developing country contexts, particularly for high quality studies.

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However, plenty of caveats• Design of the PRP is key — badly designed incentive

schemes can result in “gaming” the system.

• Lots of design elements to consider — what aspect of “performance” is to be measured, how is it to be measured, what will be the size of the performance bonus, group vs. individual bonus.

• Few studies follow up PRP effects over a long period of time — positive findings may be due to Hawthorne Effects that dissipate over time.

• How does politics effect PRP? May be difficult to give performance bonus to only few staff 21

Gaming

22Frequency distribution of ambulance response times for life-threatening emergency calls in UK

Source: (Bevan and Hamblin 2009)

3. Longer term career incentives

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Longer-term incentives are less information intensive

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• Evidence of effort and ability gradually emerge as staff undertake a variety of different roles

• Much performance information is tacit/reputational – more likely to be accurate (but harder to refute if inaccurate)

Longer-term incentives may be harder to “game”• The proposition is that it is hard to cheat about effort and ability

over the long term

• Long term incentives may also be more in line with intrinsic motivation

• Types of long-term incentives:

• Competitive promotions

• Deferred compensation

• Reputation

• Necessary conditions• There must be a real risk of not getting promoted based on

performance

• There must be room for career progression

• Pay must be sufficiently decompressed25

5. Pay reform options

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Why change?

What is the evidence that the system is broken?

1. Is there an agency productivity problem?• Review the ability of the public sector to attract

and retain necessary skills

2. Is there an individual effort problem: • Assess the degree to which current

management arrangements are minimizing absenteeism and are keeping staff “engaged” in the agency’s mission.

3. Is there a public sector wide problem:• Is the wage bill fiscally sustainable?

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Look for a right balance between long term and short term incentives

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Maximizing extrinsic motivation

Maximizing intrinsic motivation

External incentives to perform

Long term Can provide motivation

Can provide motivation

Short term Can provide

powerful motivation

Can demotivate

If a significant move towards PRP is contemplated – pilot and leave an escape hatch

• Pilot in a craft job — teaching, revenue collection, health

• Meticulous focus on the design

• If possible, build in an impact evaluation

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Thank You

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