This paper examines how the removal of national pay scales, a common feature of public sector labor markets, affects productivity. We exploit a reform that compelled all schools in England to replace pay scales with school-designed performance related pay schemes. Using teacher-level data, we find that in response to the reform, schools in labor markets with better outside options for teachers have higher relative teacher pay progression, spending on teachers, teacher retention and student performance. These effects are largest for schools with a more disadvantaged demographic. We conclude that centralized pay scales result in a misallocation of resources by preventing such schools from retaining their teachers.