Evaluating a teacher's work has many facets. The easy one, because it can be expressed in figures that naturally rank themselves, is exam or skills tests results. Unfortunately, these easy-to-understand numbers do not meaningfully reflect the job description of a teacher.
I agree with her that simplistic pay schemes that relate test marks to pay are not going to work. As Wheeldon points out, they will simply encourage teachers to teach to the test, or as demonstrated in Freakanomics, teachers will blatantly alter exam results to ensure better pay.
Her alternative plan to give principals more power to hire and fire is only a partial solution. Fundamentally, it does not provide the good teachers with any bonuses or extra rewards (instead it only punishes excessively bad teaching). The key problem with current arrangements is that the good teachers are also likely to be able to get rapid promotion in the private sector. So why would they go to a school where, no matter how well you teach, you might be waiting five years for a pay rise? No wonder most of my teachers were lemons.
However, it does get to the root of the problem of centralisation. As Friedman points out for the US:
When I went to elementary school, a long, long time ago in the 1920s, there were about 150,000 school districts in the United States. Today there are fewer than 15,000, and the population is more than twice as large.
If there was a functioning market at the consumption level then this would put sufficient pressure for the design of efficient incentives in input markets. But if we try and tack a merit pay system on to the existing centralised, beaucratic structure then, given their track record, departments will probably stuff it up. As Friedman argues, in the absence of market pressure, power needs to be put closer to consumers in some other way. Although, allowing principals to fire has some merit, vouchers have more.
PS: In other Friedman related links, his Free to Choose documentary is now available in full on google video. And, as Gregory Mankiw, points out here's another video that Milton would probably warm to.