Bank of Canada performance, and performance pay?

I don't have any strong view on performance pay in general, on performance pay for public sector workers, or on performance pay for workers in the Bank of Canada in particular. And I'm going to stay silent on whether the Bank of Canada had good performance in 2009 (or 2008, if there's a one-year lag?). But I do want to take issue with this one argument against performance pay at the Bank of Canada (and, by extension, against performance pay for all public sector workers).

From the Toronto Sun:

But even though the amount is small, NDP MP Pat Martin said bonuses for public employees is "offensive" as a matter of principle.

"The Bank of Canada is not a private business. It's not tied to performance or productivity outcomes," Martin said. "It's not a profit-making venture where you can measure a good year from a bad year ... What is the merit they are being rewarded for, coming to work on time?"

First, just because the goal of an organisation isn't profits, doesn't mean its performance can't be measured.

Second, measuring the performance of a private business - measuring its profits - gets pretty fuzzy too, in practice.

Let me start with the second thing first.

Any competent accountant could write this paragraph better than me. There is more than one measure of accounting profits, and even if you accept one set of accounting principles, there may be borderline cases where it's either a bit of a judgment call, or where the decision depends on an overly-fine and arbitrary distinction, on what to count in revenues and expenses. Most of these cases may simply involve shifting revenues and expenses, and hence profits, from one accounting year to the next, but even that matters, for the bonus of an employee who might not be around next year.

Then there's the whole question of accounting profits vs economic profits; historical costs vs opportunity costs, etc.

Then there's risk. Suppose the managers gambled the firm, got lucky, and won. We don't observe what would have happened if they had gotten unlucky and lost, and we don't observe those probabilities either. So we don't observe the expected profits, only the actual realisation. And even expected profits aren't exactly the right measure of performance, if the owners are risk-averse.

And there's the whole separate question of how you might measure an individual worker's marginal contribution towards those profits.

Measuring performance is fuzzy, in other words, even in the private sector, even if you assume the goal is "profits". So it's no argument to say that public sector workers are different from private sector workers in this regard. You would need to argue that measuring performance in the public sector is even fuzzier. Maybe it is. But that's what you need to argue.

Back to the first thing.

The Bank of Canada's performance can be measured. That measurement will be a bit fuzzy, sure; but then all measurements are fuzzy, in practice.

The first goal of the Bank of Canada is to keep inflation close to the 2% target. Its performance on meeting that goal can be measured. Again, it will be a fuzzy measurement. Core, or total CPI? Averaged over what time period? Did inflation temporarily depart from the target for reasons the Bank could not have foreseen, and/or which it would have been undesirable for it to try to prevent?

A second goal is to preserve stability in the financial system. That's even fuzzier to measure. But anyone who says that Canada's financial system has survived the last two years better than most other countries' is ipso facto measuring it.

And so on.

Again. I'm not coming down one way or the other on this question. I can't decide. But the argument that you can't have performance pay in the public sector because the public sector doesn't try to maximise profits is a bad argument.

If you want a better argument, maybe argue that the public sector is better driven by an ethos of service and honour, and that performance pay might undermine that ethos? I'm not sure if it's right. But at least it's not obviously wrong.

Comments

[Brian Finch]

Journalists also claim to be motivated by an ethos of service and honour, too, don't they?

[Neil]

Performance pay makes sense, in both public and private sectors, so long as there is a predetermined formula for establishing it, and that said formula could realistically kick out a big fat zero if targets are not met. Some people, such as the president, should be tied to the overall bank's performance indicators (inflation, number of institution failures, a big fat zero if a bank needs to be bailed out, etc.), but lower level employees should have more job specific goals. It's not really that complicated. The formulas can be rejigged at the beginning of each year if there's a management decision to concentrate on improving in certain areas.

In practice a lot of bonuses in both public and private organisations have nothing to do with performance and are therefore useless. I get a bonus if my company turns a profit, something that I (being part of the administrative overhead) have no involvement in generating. AIG employees effectively get deferred signing bonuses regardless of how much they screw up. In both these systems, the bonuses don't encourage people to do a good job, merely to do a good enough job to avoid getting fired...pretty much the same incentive that their regular wage should be providing.

[Just visiting from Macleans]

Suppose we had the same merit system in place for PMs. Would we have the GST and the Canada-US Free Trade Agreement, or NAFTA? Doubtful. Mulroney's PC party was reduced from the largest majority in Canadian history (at that time) in 1984, to two seats in 1993.

Still, maybe he could have cashed in on Canada being named #1 on the UN's Human Development Index during his tenure - not bad for an Irishman from Baie-Comeau, as he says.

[Andrew F]

"I get a bonus if my company turns a profit, something that I (being part of the administrative overhead) have no involvement in generating."

Not necessarily true. My bonus is also based in part of profit even though I work in a cost centre. My firm's rationale is that everyone in the firm should have some of their bonus based on profit, even cost centres, because a dollar saved is a dollar earned. It also keeps focus on total system cost, rather than trying to locally optimize their part of the business. I agree that it's tricky though.

And I agree, Nick. Pat Martin's argument is appalling, and indicative of the knee-jerk anti-business attitude held by some in the NDP.

[myron]

"the argument that you can't have performance pay in the public sector because the public sector doesn't try to maximise profits is a bad argument."

I do work for a public sector organization and we do have management performance bonuses. The bonuses are predicated on the organization meeting a variety of performance metrics. I believe they are useful (not just because I am delighted to have received the bonus over the past few years), however a few comments:

1. The bonuses are the same for all managers based on how well the organization as a whole met the metrics. There is no bonus sytem for individual performance. The link between individual contribution and the outcome that would generate incentive pay is very weak. I think the belief is that individual or even department wide performance bonuses would cause disgruntlement.

2. Those that design the metrics and verify that they have been met or not also receive the bonus. And the organization has little interest in not issuing bonuses and dealing with the wails of despair from management.

3. Metrics for public sector organization are more difficult to design than private organizations. Earnings, profits, market share are definable targets that are measured by the organization anyway whereas the public sector organization likely has to design something novel. That said, any organization will have done business planning around intended activities and outcomes, so perhaps I am overstating the difficulty here. But it is much more difficult to determine whether a public sector organization is doing its job well, and requires a thorough consideration of its mandate and its stakeholder interests, which often conflict. Quite often these can lead to performance measures that are at odds with eachother (eg, 'public contribution indices' via poll data vs. any policy direction that creates hard choices and winners and losers). Or this difficulty creates a situation where the metrics are more capable of being 'gamed' in a way that makes the bonus more likely.

4. Over time, the bonuses become simply default additional pay, and not a true "bonus". This is no doubt the same problem in the private sector -- eg the AIG guys getting bonuses after the meltdown.

5. Bonuses can be used to skirt around the sometimes rather ...ah... conservative expectations around salary that the public has towards public sector workers. Shareholders are more tolerant of salaries that reflect talent than the public. Plus public sector salaries can be obtained through freedom of information, whereas private salaries are ... private. And the public may not tolerate a midlle manager making 6 figures, though it might tolerate that manager making, say 80k. Oh, did we mention there was a 15k bonus?

[Jim Rootham]

Pat Martin did not express that very well.

There are a lot of problems with performance pay and bonuses, one of the fundamental ones is that it is impossible to design a system that can't be gamed. Which, if you consider it, is what happened to the financial system, the senior managers gamed the system to get theirs and took the whole system down as a result.

[Nick Rowe]

Jim: Yep. A lot of us say things that on reflection don't make any sense. It's not a hanging offence. (Just as well, or this blog would be enough to hang me several times over!)

It's impossible *in (nearly) all practical cases* to design one that can't be gamed. Question is though, how big are the costs from that gaming, vs any alternative system? Dunno. I expect it depends.

I had the private financial firms in mind as I was writing this post. Hope everyone got that. Maybe I should have made it explicit.

[Jim Rootham]

Here is what one business writer has to say on the subject:
http://www.joelonsoftware.com/articles/fog0000000070.html

There are links to other commentators there as well.

[Erin Weir]

Nick, I agree that there is such a thing as performance without profits.

You conclude: “If you want a better argument, maybe argue that the public sector is better driven by an ethos of service and honour, and that performance pay might undermine that ethos?”

Martin is quoted making that sort of argument later in the same article: “It creates backstabbing in the public service, stepping on others to get ahead. It’s counter-productive to any kind of cooperative approach to public service.”

[myron]

"cooperative approach to public service"

...say what now?

[Jim Rootham]

What about that statement didn't you understand?

[Nick Rowe]

Erin: Yes, he does sort of say something similar later. But it's so undercut by what he said earlier: "The Bank of Canada is not a private business. It's not tied to performance or productivity outcomes,"

That's the last thing we want to be telling public sector workers, that what they are doing at work has nothing to do with performance or productivity outcomes. We want them to cooperate, or have an ethos of service and honour (or whatever), precisely so they *do* work to promote performance and productivity.

(FWIW, when I spent a year at the Bank 10 years ago, they *did* seem to have that ethos.)

[Andrew F]

“It creates backstabbing in the public service, stepping on others to get ahead. It’s counter-productive to any kind of cooperative approach to public service.”

I find it incredible that some would think this is not the case to some extent. At least, reasonably designed incentives would not increase this dynamic.

[Nick Rowe]

Andrew: You lost me. Care to rephrase with fewer negatives?

[myron]

"What about that statement didn't you understand?"

I applied it to a number of my colleagues.

[Nick Rowe]

I think myron makes some good comments about the practical issues. One point I want to add though. Even if all managers share the same bonus, with no individual-specific bonus, it can be argued that the managers then have an incentive to monitor each other, to make sure none of their colleagues are slacking off.

There's that (apocryphal?) Stephen Cheung(?) story about seeing a dozen guys in China pulling a boat, being whipped on by another man. He thought it was terrible, then discovered that the dozen guys pulling the boat had hired the man with the whip!

[myron]

"At least, reasonably designed incentives would not increase this dynamic."

True. Humans will be humans, and self interest is at work even among those that work for the public sector (gasp!). I don't think incentives will ever eradicate the office politicking that is the lifeblood of public sector work, though it may improve performance, depending on the metrics that are applied.

Also I don't know that cooperation is necessarily equivalent to productivity. Groupthink can be a real scourge, for example, and constructive conflict can be productive. Bureaucracies do need "uncooperating" internal systems of checks and balances.

[Andrew F]

Nick:

I'm surprised that some would think that there is no competitiveness/politicking/backstabbing going on between bureaucrats. There is still a ladder to be climbed. Reasonable performance measures and compensation should not necessarily increase this level of competition.

From organization design theory, we know that more or less cooperative organizations can be more effective, depending on the goals. I don't think anyone is advocating we make the public service an 'every man for himself' battle royale, but hardly any private organizations could or do function this way either.