Applying the theory of yardstick competition to the schooling system, we show that it is optimal to have central tests of student achievement and to engage in benachmarking because it raises the quality of teaching. This is true even if teachers' pay (defined in monetary terms) is not performance related. If teachers value reputation, and if teaching output is measured so that it becomes comparable, teachers will increase their effort. The theory is tested using the German PISA-E data. Use is made of the fact that central exams exist in some federal states of Germany but not in all. The empirical evidence suggests that central exams have a positive effect on the quality of teaching.
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