High-powered incentives can reform our bureaucracy

The challenge of bootstrapping India out of the third world and providing one-fifth of humanity with a halfway decent standard of living is enormous. It calls for a skilled, motivated and agile bureaucracy. As my previous article argued, to inject India’s bureaucrats with enterprise and shake them out of lethargy, a radical re-evaluation of their incentives is overdue.

A wealth of anecdotal and academic evidence supports the deployment of high- powered incentives for transforming the bureaucracy from an albatross around the public’s neck into an engine of growth. In China, xiahai, or the practice of bureaucrats joining state or private enterprises, tends to incentivize them to push the economic transformation of their regions in order to improve their own employment prospects after they leave public service. Acquiring a reputation for being ‘pro-reform’ among potential private-sector employers also motivates them to promote economic growth. On making the switch, many find that some of the bureaucratic regulations they had helped maintain are obstacles to their business interests, and then lobby to have them axed. Thus, Xiahai underscores the power of incentives in transforming a moribund bureaucracy.

The remarkable enterprise of China’s bureaucrats is documented in a fascinating book, How China Escaped the Poverty Trap, by Yuen Yuen Ang. The author argues that the bureaucratic entrepreneurship which transformed China’s economy can largely be attributed to pay reforms. The low base pay of bureaucrats was supplemented with high add-on pay for economic performance. Similarly, the bureaucracy of Singapore enjoys high supplemental pay that incentivizes performance. Bureaucrats in Singapore can earn four types of performance pay—a non-pensionable annual allowance, an annual variable component, a performance bonus and a national bonus. All this can add up to 20 months of a bureaucrat’s regular salary.

In a seminal paper titled Reforming Public Bureaucracy Through Economic Incentives?, Susan Rose-Ackerman shows that a sense of professional duty is usually inadequate to motivate public servants, and other incentives such as plum postings are too weak and/or randomly assigned (with high error rates) to act as strong motivators. This, coupled with no incentives for information generation, makes bureaucrats risk-averse and unproductive. She argues that financial incentives can often solve these problems. In an empirical study (2018), Imran Rasul and Daniel Rogger found that well-designed financial incentives have a positive effect on project completion rates for the Nigerian Civil Service.

Promoting bureaucratic performance through high-powered financial incentives has other advantages as well. In contrast to monitoring or control-based measures, these have the potential to reduce corruption without increasing procedural complexity and processing frictions. Also, this approach to reforming the bureaucracy is flexible. Targets and performance measures can be changed as per the changing needs of the public/state. The incentives can also be tweaked and fine- tuned over time. Several research studies have shown that bureaucrats in different functions have different risk preferences. For example, a bureaucrat in a more visible function may be more risk-averse (due to the higher cost of visible failures) than one in a less visible role. Financial incentives allow for heterogeneous risk preferences and targets. Various functions and departments can have incentives designed specially for their performance objectives.

Also, financial incentives can be imparted a ‘tournament’ like structure, which helps maintain motivation even in situations where outcomes are shaped by uncontrollable factors. Such incentives are also more likely to induce a broad catharsis of the bureaucracy through the ‘reverse Gresham’s Law effect’, as Rose–Ackerman points out. Gresham’s Law posits that bad money drives good money out of circulation as people hoard good money and transact with bad money. In a system with well designed financial incentives, ‘good’ bureaucrats will earn more, be more visible, and face high demand for their skills, thereby driving ‘bad’ bureaucrats into oblivion or forcing them to reform. Lastly, unlike India’s Pay Commission recommendations, the budgetary implications of this scheme can be controlled ex ante by linking payouts to fiscal performance.

To be sure, implementing a system of financial incentives is not without its share of challenges. For this system of contracting to work in a government setting, performance will have to be objectively defined. A clear link between effort and performance metrics will have to be established, and bureaucrats will have to be given ex-ante knowledge of these metrics as much as ex-post visibility. Incentives will also have to account for the randomness of outcomes, the risk aversion of public servants, and the fact that results may depend on inter-departmental cooperation in several cases. Such concerns about performance measurement, however, are somewhat anachronistic in this digital age. The challenges of tracking and evaluating performance could be surmounted through a thoughtful application of technology.

In sum, unlike monitoring and control-based measures, which have failed to reform the Indian bureaucracy, promotional measures that incentivize good performance are a powerful, comprehensive and flexible approach that would help India’s babudom achieve its ‘Weberian’ ideal.

Diva Jain is director at Arrjavv and a ‘probabilist’ who researches and writes on behavioural finance and economics. Her twitter handle is @DivaJain2