The Free Market 13, no. 4 (April 1995)
Performance budgeting (PB) is the newest strategy to make the public sector work. Yet as with other similar strategies, PB is fundamentally flawed. Without a system of profit and loss, a bureaucracy not only has trouble motivating its employees; it can’t determine the value of what they are doing in the first place.
The social sciences have traditionally treated government employees as benevolent, self-sacrificing individuals who have answered a high calling: serving the public interest. The reality is different. Casual observation suggests public sector workers are no different from anyone else.
They may be conscientious, but they also have mouths to feed, mortgages and health care payments to make, credit card debt, and all the other modern-day headaches that plague the average worker. They choose public-sector work for the same reasons anyone chooses a job: the paycheck, the location, the security, the work environment, advancement possibilities, etc.
If the people who make up the government are no different from the rest of us, how do you motivate them? That’s what PB, part of the “reinventing government” fad, is supposed to do. Under PB, you first measure the performance of agencies and then use those measures to hold agencies accountable.
The first stage is trickier than it sounds. For the sake of argument, suppose public agencies can identify and measure their yearly outputs (number of fires extinguished, number of welfare mothers serviced, number of firms prosecuted for regulatory violations, etc.). Still, the real problem remains: how can you measure the value of these activities?
Consider the Food and Drug Administration as an example. It is supposed to keep unsafe and ineffective drugs off the official market. How do you measure what it does? Count the number of new drugs it tests and rejects each year?
The problem is this. If the FDA keeps bad drugs off the market, it also keeps good drugs off the market. The approval process has become so horrendously expensive that new life-saving drugs are either not brought to market or experience lengthy delays.
While the FDA may see the value of what it does as keeping bad drugs at bay, the reality is that people die from delays. Any measure of the value of the FDA’s activities should account for lives lost due to delays caused by its tangled regulatory process.
While measuring government activity is tough, it’s not as tough as measuring what really matters—the value of that output to society. Only after answering the value question can anyone in good conscience talk about rewarding or punishing those responsible.
How do we assess value? The marketplace answers the value question with prices and profits. The value of a product is reflected in its price (determined by supply and demand) and the value of a business, through its profits (dollar sales minus costs).
If profits are big, those responsible get pats on the back and monetary rewards. If profits are small, those responsible get pats-on-the-back. If profits are negative (losses), those responsible are eventually let go.
Profits are a reflection of the market’s valuation of a firm’s output, and correspondingly, the valuation of its inputs (workers, etc.). How does all this translate to government agencies? It doesn’t, or at least not very well.
While most businesses face competition, public agencies do not. They are monopolists. While most businesses earn their budgets, and can save or reinvest any savings (profits), public agencies are granted a budget and operate under the “use-it-or-lose-it” principle.
Providing quality products at reasonable prices is how competitive firms survive. Monopolies do not face the same price and quality concerns. A case in point is the collapse of the Soviet economy, which was caused by public agencies offering inferior products at arbitrary prices.
The problem with use-it-or-lose it budgeting is this: the public agency argues for the biggest budget possible. What they get and do not spend gets cut from next year’s budget. That provides incentives to expand, using resources to get a large budget and then spending every dime. If the bureau acts efficiently and saves, it is punished.
Under current budgeting, saving money is potentially disastrous. Price and quality concerns are secondary. And the value of what you do rarely comes under review.
Performance budgeting is also supposed to motivate people better than thumbscrews. Let’s assume that what the government does is basically okay, ought to continue, and can be measured. Let’s eliminate the thorny first-stage problem of placing a value on what agencies do. We still have to address the problem of knowing what to reward and what to punish.
Whether performance is rewarded through money or recognition (as some critics of PB suggest), a more fundamental problem is ignored. If the performance measures are wrong—to return to the FDA example: measure drugs tested vs. lives saved—what is it you are rewarding or punishing? If you can’t measure the value of what a public agency does, and the private sector can provide the service competitively, contract it out or cut it.
