Bryan Caplan  

The Red Herring of Principal-Agent Problems

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The Bad Old Days of 1994... Heroes Call Me Friend: Formal ...

Tim Besley's Principled Agents? is supposed to get a full issue's worth of attention from The Review of Austrian Economics in the near future. Here's my review essay, and here's my favorite part (endnotes and references omitted):

[P]olitical agency problems are often a byproduct of voter irrationality. The principals give their agents grossly suboptimal incentives, then complain that the agents fail to carry out their assignments.

For example, a key feature of the main models in PA is that there is no pay-for-performance. No matter how good or bad a job a politician does, he gets the same compensation.

Admittedly, this is a standard feature of modern democracies. But why is it a standard feature? Because it is too hard to evaluate politicians’ job performance? If so, using re-election as a carrot is equally misguided. Because it is too hard to assign optimal weights to various aspects of job performance? If so, one could simply “let the people decide” the optimal weights by basing bonuses on approval ratings. Because politicians’ actions have long-run consequences? If so, bonuses could be a function of long-run consequences...

[T]he flimsiness of the leading objections should open us up to a simple alternative: Pay-for-performance is a good idea, but the public is too irrational to accept it. As Caplan explains:

Many [voters] prefer to see politicians as altruistic public servants, a breed apart from the self-interested inhabitants of the non-political world. Given public choice scholars’ determined efforts to discredit this viewpoint, they can hardly argue that this mistake is not widespread.
Brad DeLong coincidentally makes a similar point in one of his most perceptive posts:
[C]ourts are the natural habitats of deceitful courtiers who tell the princes exactly what the princes want to hear, the people on the spot who control implementation matter in ways that the people around polished walnut tables in rooms with green silk walls do not, and the movement of information through bureaucracies does resemble a game of telephone with distortions amplified at every link.

But.

Those with sufficient virtu to become princes in this modern age are well aware of all these deficiencies of bureaucracies and courts.

[...]

But by the time anyone (a) possesses sufficient virtu, (b) is forty-five or fifty-five or sixty-five, and (c) has seen the world, there is no excuse for not understanding that as a czar your cossacks respond to the incentives you set them, that you can change those incentives, and that you are responsible for the behavior that your incentives elicit. By the time you are forty-five or fifty-five or sixty-five, you know very well that when you say that "intelligence has been 'too timid' in the past," what they hear you saying is "don't tell me what you think, tell me what I want to hear."

[...]

The frictions and distortions of the bureaucracy and the court exist. They are, however, counterbalanced by the intelligence, the sophistication, and the energy of the principals at the top. If the czar wishes, the cossacks do work for him. And if the czar doesn't want to take the time to make the cossacks work for him--well, that is his decision and what happens is his will just as well.

When you tell the manager of a restaurant that your server was rude, he rarely says, "Don't blame me, I didn't tell him to be rude." It's a lame excuse - and it doesn't get any lamer when a politician hides behind it.


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COMMENTS (9 to date)
John Thacker writes:

If the czar wishes, the cossacks do work for him. And if the czar doesn't want to take the time to make the cossacks work for him--well, that is his decision and what happens is his will just as well.

This is, of course, considerably less true in a bureaucracy with civil service unions than under an actual czar or with the old spoils system. Bureaucratic rebellions against political appointees and their incentives do exist. Sometimes it is indeed difficult to "change those incentives."

Robin Hanson writes:

While leaders may be able to spread dozens of loyal spies around to secretly inform them, this tactic seems much less available to voters. So this still leaves room for principle agent problems between voters and leaders.

John Thacker writes:

When you tell the manager of a restaurant that your server was rude, he rarely says, "Don't blame me, I didn't tell him to be rude." It's a lame excuse - and it doesn't get any lamer when a politician hides behind it.

Do you mean to say "doesn't get any less lamer?" But surely you have noticed a difference in behavior and rudeness between unionized employees and not, particularly in strong union states? I have; I have had quite a few friends whose managers have essentially told them just that about uncooperative co-workers: "Don't blame me, I can't do anything because of the union." I have been in European restaurants where the service was horrible, particularly after ordering and, perhaps not coincidentally, there was no tipping. Not that such is real data, but surely principle agent problems do exist in private life. Principle agent problems also exist in companies and areas where it is difficult to judge results.

While pay-for-performance and bonuses sound like a good idea, surely you admit that they are not used in all situations and workplaces. Is that because of irrationality? And if so, does that affect your hypothesis that the effects of irrationality are much worse in public life than private life, due to not paying the true marginal cost?

Wes Johnson writes:
one could simply “let the people decide” the optimal weights by basing bonuses on approval ratings.
Pay-for-performance is a good idea, but the public is too irrational to accept it

Too "irrational" to accept a cockamamie scheme of tying politician's bonuses to approval ratings? "Harebrained" comes to mind too. How would that work exactly? Do you really think that's a well thought out plan that could actually be implemented? I bet you don't have a such a plan that voters could, if only they were rational, adopt as the standard method of compensating politicians. (If you do, I would honestly be interested in seeing it.)

FC writes:

If DeLong actually believes that bureaucrats, especially in intelligence, don't begin by accomodating what they perceive their bosses' desires to be, he has no business calling himself an economist.

Tom West writes:

Whatever happened to to the expectation of simple professionalism? My experience is that most people do their best simply because that's what they've contracted to do.

There are certainly going to be exceptions to that rule, but in my years of working as a programmer under contract where non-technical employers must simply trust the professionalism of their employees, I've never seen a programmer do anything but their best, despite the "incentive" to draw a project out (since they get paid by the hour).

Incentives might matter, but I think for most people, the incentive that matters is the ability to view themselves as responsible, professional, efficient, and trusted.

Tom writes:

"If DeLong actually believes that bureaucrats, especially in intelligence, don't begin by accomodating what they perceive their bosses' desires to be, he has no business calling himself an economist."

I don't know. Hillary confirmed that the intel on Iraq was what the Clinton white house saw.

Two different bosses with very different desires. I think the Intelligence community has their own agenda and who's in office doesn't matter much, as it's only temporary. (this is really anonymous, right?)

John Thacker writes:

US intelligence, foreign intelligence, and even Hussein's own high-ranking army officers all believed that there likely were WMDs, and US intelligence believed this before 2000 as well, or at least top Clinton Administration sources said so at the time. So of course it's somehow all Bush's fault.

Plenty of reasons to not go into Iraq, but the idea that the intelligence was distorted significantly is hard to accept. (Plenty of reasons to believe that people would judge differently what degree of likelihood would be required, certainly.)

DJH writes:

Every post encouraging pay-for-performance for politicians is invalid because it depends on a preposterous assumption. The proposition that salary is the critical compensation for elected officials is nakedly ridiculous.

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