Moving to

I'm moving to Mostly.

I plan to use that site as a "self-marketing website" of sorts and to manage content in a way that I would otherwise not be able to do on blogger alone.

This blog will stay, ostensibly for more provisional ideas prior to refinement. I'll be gradually moving content (I still like) over to the other website. =)

Monday, October 31, 2011

On Pay For Performance

Ministerial salaries in Singapore are a bit on the high side. In a just world where everything fit, that fact would imply that Singapore is prospering (check: more or less) and the people are extremely pleased with government services, the business environment, their standard of living and the direction the country is taking. On the latter count(s), it would take tremendous sampling bias to check those off today. Thus, there appears to be a remuneration mismatch which I will attempt to delve into.

In this opinion piece, I will discuss the basis of ministerial remuneration and pay for performance. I will talk about the inadequacy of using GDP growth as an indicator and show, by example, how one may easily develop better indicators. My intent is to contribute to the discourse on how we may more precisely reward good performance on the part of our ministers and provide incentives for good policy making.

The Basis for Remuneration
The nation's leadership must be properly remunerated for the time they put in to policy making and for the associated burden of responsibility. Remuneration for this base-load of effort would be partially covered by the non-variable component of their salaries. In addition to this, the nation's leadership should also be rewarded (or punished) for facilitating good (or poor) social, economic, security or foreign relations outcomes. This position is very much in line with what the ruling PAP government has argued in explaining the justifications behind their salaries. While I agree with the idea of pay for performance, I feel it has not been properly implemented.

On Performance Evaluation
What is good performance for government and how can it be evaluated? Presently, GDP growth is used as an indicator that determines a significant portion of ministers’ (and senior civil servants’) bonuses. By and large, it is agreeable that this is insufficient to cover the gamut of areas where government has a significant impact.

In addition to the above, a significant portion of ministerial bonuses is confidential and known only to the Prime Minister and the minister in question. We shall assume that the Prime Minister is privy to the efforts that each minister puts in and is qualified to judge the quality and effectiveness of the initiatives put in place by each minister. Behind this appears to be the assumption that the body politic is not qualified to properly judge these and their input could have a distorting effect on rewarding the deserving and punishing the blundering. This is only partially correct.

Before elaborating on why, let me enumerate on the major components of performance: (i) the standard of living of the body politic, (ii) the delivery and effectiveness of government services, (iii) the state of the business environment, (iv) economic and geopolitical security, (v) the direction of the country and (vi) the effort put in by individual ministers.

I believe that it would also be agreeable that while the body politic are able to evaluate (i) thru (iii), they are not equipped with the information and knowledge to evaluate (iv) thru (vi). Conversely, the Prime Minster is far less qualified than the body politic to evaluate (i) and (ii). The Prime Minister may also be less qualified than the average business owner to evaluate many aspects of (iii).

While we might conclude that the Prime Minister and selected advisors should be the ones to evaluate (iv) thru (vi), and to some extent, (iii), we might also conclude that there are gaps in the evaluation of (i) thru (iii). Furthermore, it is (i), (ii) and aspects of (iii) that the body politic care most about and are most qualified to evaluate. As it is impractical to award ministerial bonuses by referendum, proxy indicators must be used to measure these effects that arise indirectly from the actions of our ministers. These proxy indicators must also be formulated such that the body politic would agree that they measure the aforementioned elements of performance.

On GDP Growth as an Indicator
GDP growth has little relation to (iv) thru (vi), it is also only weakly correlated with (i) and (iii). However, it would appear that GDP growth is, in some sense, being used as a catch-all to evaluate the changes in standards of living, the state of the business environment and even the quality of government services. Supporting the truth of this hunch is the fact that a substantial portion of ministerial (and civil service) bonuses depend on the level of GDP growth. If this does, in fact, reflect reality, then there is a problem.

I would like to, first, justify the inadequacy of GDP growth as an indicator by quickly explaining why GDP is only weakly correlated with (i). There can be many economic outcomes (states) in which GDP growth can be high but large segments of the population experience decreasing standards of living. It is the existence of these outcomes and the likelihood of their occurrence (we have been experiencing these outcomes in recent years) that justifies the contention that GDP is only weakly correlated with (i).

(Note: A more precise mathematical statement on the inadequacy of GDP growth as an indicator could be made along the above lines. In addition, except for effects arising from the regulation of businesses and promotion of competition, it is difficult to relate GDP growth to (ii). Also, it would take more effort and business /economic reasoning to explain why GDP growth is ineffective as an indicator for (iii).)

Proposing a Better Indicator
More effective indicators can be easily developed. As an exercise, consider using real household income growth to build one. We will use a weighted sum of average real household income growth of various segments of the population. For example: 0.5 times the average growth of the lower 50% plus 0.5 times that of the upper 50%. Extending that logic, consider measuring at finer granularities such as 10% segments of households or even 1% segments. For weights, we adopt the "democratic option" of equal weight being given to each individual regardless of income level, which is consistent with our electoral system. Let us call this indicator "Aggregate Real Household Income Growth" (ARHIG) and suppose that ten equally weighted 10% segments are used.

This indicator is consistent with findings in behavioral psychology where percentage growth is what matters and not absolute growth. In addition, prospect theory, which has been empirically verified in a wide range of activities involving expressions of preference, informs us that losses loom larger than gains, which suggests that percentage income contraction should be weighed more heavily than growth. Naturally, the difference in weight between growth and contraction should be determined by a proper survey.

Clearly, ARHIG and similar indicators correlates far better with standard of living. In fact, one could reasonably argue for a causal relation. Furthermore, income growth at all levels may be a better measure of the quality of the business environment as it measures the benefits derived by all elements of the economic hierarchy. I have not thought about this in sufficiently detail and thus can only make a conjecture. On top of all this, ARHIG is eminently easy to explain to the body politic.

As the this section indicates, it is possible to build indicators that are more relevant to ministerial remuneration. I believe in this short section, I have convincingly argued that the ARHIG that we have sketched out is superior to GDP growth as an indicator for standard of living. Competent government economists should have proposed something like this at several points, and if it was, I wonder why it was rejected each time.

Admittedly, we have worked on an indicator for the aspect of performance that is easiest to measure. With more work, one could describe an indicator for (ii) and (iii), though my sense is that a survey of sorts would be needed, necessitating a (secret) sampling process.

Summing Up
In this unexpectedly long opinion piece, we have discussed the basis of remuneration and the measurement of the various aspects of performance. I have explained why GDP growth is a poor indicator for improvements in the general standard of living. To show that it is not difficult to build more relevant measures, "Aggregate Real Household Income Growth" (ARHIG) was presented as a simple indicator that more directly measures improvements in the general standard of living. The fact that such indicators are not used do not square with the fact that many Ivy League and Oxbridge educated economists are working in government ministries. Without good indicators, "pay for performance" does not mean anything. Thus, the failure to use better indicators should be explained. In so far as the ruling party is correct that rewarding good performance is a vital ingredient for good government, the lack of good indicators of performance is harmful and is a problem that should be addressed with haste.

Afternote: I've computed ARHIG for 2001 thru 2010 using data from SingStat, though it is annoying to reproduce them on a blog. (So I shall be lazy and not do so.)

There is one interesting tidbit though, real household income growth over 10 years has generally not been too shabby except for the lowest earning 10% of households. They experience a -6.55% contraction in real household income. (The 11-20% decile has 10%, the 41-50% and 51-60% have about 23%, and the 91-100% have 34.85%.)

However noting that SingStat's income data excludes government transfers, such as WorkFare, we see that measures are being taken to close the gap. In fact, a quick look at the Workfare Income Supplement numbers reveals that that WorkFare would result in real household income growth over 10 years for the lowest 10% of households of around 5% to 8%.

On the flip side, these (few) numbers do not provide a clear picture as only households with at least one working member are counted. Ideally, unemployed households should also be accounted for.

Afternote 2: This article was also published on New Asia Republic.

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