Pay for performance in the public sector: the challenge of fairness

Abstract

This paper contributes to an explanation of why pay for performance (PFP) in the public sector has difficulties in functioning properly and why, despite the difficulties, its use is continued. To do so, the paper draws on insights from behavioural economics. The explanation focuses on cognitive biases in the way people process information. These biases, affecting employees as well as managers, are reasons for employees' perception of unfairness in the allocation of PFP. Attempts to reduce this perception of unfairness may conflict with other considerations concerning motivation and efficiency, and generate a number of dilemmas. The cognitive biases may impede managers' rational reflections on the dilemmas associated with attempts to reduce the perception of unfairness, and then also the rational choice of trade-offs. Furthermore, the cognitive biases may cause managers to underestimate the negative effects of PFP and, consequently, PFP may be maintained even if it is not appropriate in the specific context.