Go for performance-based funding | Opinion
This is critical, because high-quality research on service delivery in the last two decades has documented massive variation in the cost-effectiveness of policies to improve social sector outcomes. For instance, an unconditional doubling of teacher salaries (accounting for the majority of education spending) had zero impact on student learning outcomes. In contrast, linking even modest amounts of teacher pay to performance have been found to generate large increases in learning outcomes at a much lower cost. More recent evidence shows that performance-based incentives increase the effectiveness of resources and inputs.
In the Indian context, there is robust evidence that the quality of governance is weaker in poorer states. For instance, teacher and doctor absence rates are consistently higher in poorer states. The fiscal cost of teacher absence alone is over ~10,000 crore per year. This creates a vexing challenge for the Finance Commission, because states that are most in need of additional resources to provide basic services like education and health are also those that are likely to be the least efficient at converting additional spending into improved outcomes.
One practical way of solving this challenge is to earmark funds for a performance-based pool that will be allocated to states based on improvements in a few critical measures of human development. It is wonderful that this idea is already in the Commission's Terms of Reference. The rest of this column provides guidance on how best to implement it. There are three key principles to apply: Pick a few critical indicators; invest in high-quality independent measurement; and tie funding to improvements in indicators.
First, the number of indicators should be small to enable prioritisation and focus. They should also be based on outcomes, and not inputs or implementation of schemes. Even focusing on four key outcome indicators will enable substantial progress relative to the status quo.