A few years ago I came upon a small company that seemed to provide a strong rebuttal to the Monthly’s longtime support of merit pay. Instead of basing salaries on individual performance, it paid everyone the same— clerical workers, professionals, sales reps, accountants, even the artists. The exception was the owner and his assistant, but that seemed fair because they earned much less than other CEOs. I expected the system to engender internal bitterness since the work schedule was particularly brutal. When you’re working Saturday nights you damn well want to get paid more than those who don’t. But, on the contrary, this unusually egalitarian system forced employees to measure their performance by other standards— praise from the boss or customers, personal yardsticks of achievement, public recognition, and the general success of the enterprise. Pay was mostly irrelevant.

Granted, this company, The Washington Monthly, is not a typical workplace. In most reputable small companies, boss and worker don’t communicate through a 2 a.m. “drop off” at the owner’s home mailbox. Few companies flirt so regularly with bankruptcy. (Senator Jay Rockefeller, who was a. Monthly investor in the late 1960s and early 1970s, said it all in his federal financial disclosure report, which cited stock in major corporations worth millions. It also listed 215 shares in The Washington Monthly Publishing Corp. with a sad notation explaining that the stock “to the best of our knowledge has no value.”)

But when I left the Monthly in October 1987 and went to a more traditional company, I realized that the Monthly Management System had some advantages. Long a glazed-eyed believer in the sentimental notion that people should not measure their “worth” by how much they earn, I now, for the first time, find myself doing just that: Do I deserve a raise? Am I getting less than the guy down the hall who doesn’t work as hard? That is, of course, what merit pay is supposed to do. By making me ask those questions it’s supposed to motivate me to work harder. It didn’t, but it did give me a whole new set of worries.

Obviously there are tremendous advantages to giving individuals a direct financial stake in performing well. But as I mentally multiplied my own neuroses by the entire work force I became convinced that the challenge is to devise pay systems that. provide strong incentives but also confront the perils of meritocracy.

American mythology endorses pay for performance: Horatio Alger built success not through a good union contract but through hard work and smarts. No one who’s ever bought a 50-volume encyclopedia or a 25-year supply of Avon lipstick can doubt the effectiveness of the commission system for sales reps. And managers increasingly hail pay-for-performance too. One recent survey found that 70 percent of U.S. firms now offer some sort of performance incentive. They include traditional “merit pay” (permanent salary increases based on a worker’s individual performance), one-time bonuses, profit sharing, group incentives, or commissions. It seems like the perfect tonic for the American economy—both effective and true to our sense of fairness.

But this ignores an important fact about human beings. Merit pay rewards excellence—but not everyone is excellent. There are lots of average employees who perform adequately or worse. Most, however, do not believe they are merely average. Management surveys consistently reveal that about 80 percent of American workers believe they are better than the norm. There is, therefore, a natural demoralizing effect to many merit pay plans based on individual performance. Workers are regularly told they’re just not good enough, an assessment that they all too often take home. Conversely, arbitrariness is an underappreciated force. True, it seems unfair when a good worker and bad worker earn the same amount. But both can blame “the system” and avoid judging themselves by their paychecks.

To reduce resentment, jealousy, and accusations of favoritism, some managers base evaluations on easily quantifiable factors. This works well for some jobs. Number of chairs produced X bonus = merit pay. Other jobs are more difficult. If ever a teacher deserved a merit raise, it was Michael D. Reynolds, a science teacher in Jacksonville, Florida. He always took the extra step to engage his students. He made special arrangements with a local observatory so his astronomy students could measure craters on the moon, for example. In 1985 a group of professional chemists voted him Chemistry Teacher of the Year. The next year his colleagues named him state Teacher of the Year. But he never got a raise under the merit pay program Florida started in 1985. Reynolds wasn’t alone: the 1985 Teacher of the Year was refused a merit raise too.

Meanwhile, managers are increasingly discovering that motivating individual workers does not necessarily make a company more productive. Employees paid for individual production may be less likely to take time off to help a co-worker. Call it the Orgo Factor. Remember the organic chemistry major who put Clorox in his classmates’ science experiments to improve his standing on the grading curve? He’s now working under a merit pay plan near you.

The Orgo Factor

Merit pay advocates argue that it is particularly useful when you can’t fire the worst workers. Not only can a lazy, malicious, or incompetent worker poison the whole enterprise but his continued financial reward can infuriate the better workers. While in theory, managers can use merit pay as a way of punishing people into leaving, in practice the strategy often makes matters worse. Punish a bad worker and you’ll find out just how bad he is. If, for example, his base salary is healthy enough to sustain him and he’s got pension rights building, this employee will dig in and become even less cooperative. Ultimately the only solution to the problem of not being able to fire terrible workers is to be able to fire terrible workers.

Given these difficulties it’s not surprising that many managers don’t like to judge their employees. Time and time again, managers take the merit pay pool and give a little to everyone. Look, for example, at the largest pay-for-performance system in the country—the federal government. About 2.1 million middle-level employees are eligible for “in-grade” step increases ostensibly based on merit. But annual and biannual step-ups are so routine—less than 1 percent of workers don’t get them—that many workers don’t even realize it’s a merit system. The same forces operate in the private sector workforce. If a manager labels workers unsatisfactory he becomes responsible for making them satisfactory. Much easier just to say everyone’s done a good job.

In some areas, like teaching and police work, society as a whole can’t afford anything less than excellence. But that sentiment can’t be applied realistically to the entire workforce. If it is to prosper, the American economy must not only encourage brilliant entrepreneurs but also get the most out of the bulk of the workforce that thinks it’s above average but isn’t. Teaching them how to do their jobs better will generally work better than paying their co-workers more money.

The most promising approach is to base bonuses, to whatever extent possible, on group performance. This obviously removes the Orgo Factor. It helps make cooperation not just a warm sentiment but a precondition to a bigger paycheck. Excellent performers are valued rather than resented since they help boost everyone’s wages. Average workers aren’t demoralized by the constant reminder that that’s what they are, which is particularly important for those who are dedicated but not exceptionally talented. No system should penalize hard workers. Poor workers, meanwhile, receive sanctions much stronger than those given by timid managers—the dirty looks of co-workers.

Measuring group performance is also easier than judging individuals. Managers may not be able to tell whether an advertising team produced a good jingle because of the market researcher, the songwriter, or the lyricist. But they can tell if the jingle worked. Individual performance bonuses should be reserved for the truly stellar performers; that will help keep the real stars from leaving and is least likely to engender resentment.

Pay-for-performance systems have been heralded as a major solution for economic problems. But pure meritocracy doesn’t work because it only deals well with the winners. Tomorrow’s workplace must deal well with everyone.

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Steven Waldman

Steven Waldman is chair of the Rebuild Local News Coalition, cofounder of Report for America, and a contributing editor at the Washington Monthly.