Paying for Performance is Hard

An important observation by Arnold Kling:


When a remote authority sets incentives, people respond by manipulating the system. This fact is poorly understood by education reformers who are fond of pay-for-performance and national standards, by health care reformers who are fond of paying for quality, and by financial regulators. In fact, the quoted paragraph provides an excellent description of the financial regulatory process under risk-based capital. The banks spent much energy and time trying to manipulate the risk-based capital regulations in their favor. They got what they wanted, in terms of risky portfolios backed by little capital.

Also poorly understood by many corporate managers, in my experience.


There are periodic vogues for "scientific management" into which category fall such diverse phenomena as time-and-motion studies, extremely complicated statistics-based compensation schemes, and powerful committees that promise to eliminate wasteful and unnecessary treatment on a nationwide basis.  Then it turns out that rules-based systems are inherently weak, and they tend to be replaced by a vogue for autonomy and accountability.  Unfortunately, the change is rarely manifested within organizations--once you're encrusted with a nice, thick layer of red tape and rules, it's hard for the pendulum to swing back.  Rather, dysfunctional organizations fail and are bought or liquidated by nimbler competitors.

The government is different: it can't be replaced (really), and it's hard to generate accountability in an organization as big as the federal government.  With obvious implications.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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