Introduction -- General Issues in Designing Optimal Incentives -- Features of Public Sector Agencies: Why is the Public Sector different? -- Evidence on Incentives -- New Policies, New Research -- Conclusions

Using incentive pay to improve public sector efficiency is an important component of the UK Government’s public service modernization agenda. In this paper, we review the important issues in performance pay in the public sector, and summarize the evidence on its effects. We consider how optimal incentives for public sector workers may differ from those in the private sector, and if so, what types of incentives are more appropriate for the public sector. We investigate the reasons for the infrequent use of explicit incentives in the public sector. We summarize evidence of particular relevance to the public sector, on issues such as the impact on output of incentive pay schemes, gaming and dysfunctional behaviour, multiple principals, intrinsic motivation and team-work. Finally, we comment on the design of new policies being introduced in the UK public sector in the light of the theoretical arguments and the evidence.