Window-dressing and lobbying in performance-budgeting: A model for the public sector

Performance budgeting schemes in the public sector have to operate with imperfect performance measures. We argue that these imperfections lead to wasteful fund-seeking (window dressing and lobbying) by the administrative units that produce public services. We develop a game-theoretical model to analyse the trade-off between the productivity-enhancing effect of performance budgeting and the social waste it induces. The optimal performancebudgeting scheme crucially depends on the objective functions of administrative units, the available performance signal and the welfare function used. We compare a performance signal base on units' effort to a signal based on their output and show that the former evokes more social waste while the latter amplifies regional inequality. Forgone welfare gains or even welfare losses arise when the government is opportunistic. Our model and its major conclusions apply to a large array of publicly installed contests such as programs of international organisations like the IMF and conditional grant schemes in federalist countries.