Policy consequences of pay-for-performance and crowding-out

Crowding Theory is part of Behavioral Economics; it takes into account that human beings are motivated by both extrinsic and intrinsic motivation. In contrast, pay-for-performance intends to raise performance by making compensation dependent on the performance determined ex ante by relying on extrinsic motivation. Yet, empirical evidence demonstrates that pay-for-performance under identifiable conditions leads to undesired worker performance. As a policy consequence, the government in the public sector, as well as charitable and humanitarian organizations relying on volunteers, should be very careful to institute pay-for-performance schemes due to the risk of crowding-out intrinsic motivation. Using pay-for-performance in such activities is in most cases incompatible and inconsistent with the organizations' goals and tends to lead to poor or at least unsatisfactory work activities.