The Red Herring of Principal-Agent Problems
By Bryan Caplan
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.
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.