Principal Agent Problem November 13 2012 Mccubbins Admin Procedures as Instruments of Political Control Nielson Tierney IOs Agency Theory and WB Reform Principal Agent Problem Principal authority delegates tasks to agent have resources Agent subordinate expertise more time Problems o 1 Desires and preferences of principal and agent may not be aligned o 2 Agents can hide information and or actions Solutions 1 Incentives contracting o Positive rewards monetary compensation bonus o Negative sanctions fines extra duties o Problems Agent can still hide information and or actions principal still does not have perfect information Contracts are never perfect 2 Monitoring overseeing supervising o i e Security cameras audits o Costly money time Costs of reducing slippage has to be traded off by what the slippage could be o Settle for less than 100 of perfect quality work Examples 1 Congress Agencies o A Principals Congress and President sometimes o B Agents bureaucratic agencies o C Concerns Agencies create laws that do not benefit the public Unelected officials are not affected by public s opinion Hidden information and actions runaway bureaucracy Either do nothing shirk or are zealots for regulation over regulate o D To control agents 1 Oversight i e Audits Congressional hearings Problems Actions are reactionary the bad event already occurred o Fire alarm monitoring interested parties alert authorities when there is a problem Costly could be using time for more productive purposes Police patrols active oversight 2 Administrative procedures guidelines that agencies must follow when executing policies pgs 257 258 Makes agencies responsive to interested parties and decreases information problem Elected officials can now put the oversight on auto pilot Maintains coalition creating procedures that are responsive to public 2 International Organizations IOs o A Principal s member countries of IOs Multiple principals problematic bc becomes confusing for agent when each principal has its own preferences can send conflicting messages to agent who already has his own preferences o B Agents IOs i e UN WTO World Bank o C Concerns IO acts contrary to the preferences of multiple principals Getting principals to agree collective action problem Proximity to agent determines amount of control The closer to agent the more control over agent o D To control agents Cut funding sanctions Screen and select employees of IOs Credible Commitment Problems November 20 2012 General Credible Commitments Noorudin Coalition Politics Why Commitments May Not Be Credible promise it may not be fulfilled incentives Cheap talk you can say whatever you want but unless there is enforcement or cost behind the Time inconsistent preferences long term incentives might be undermined by short term o Both parties can have incentives to commit to the long term promise but the short term incentive might be to cheat o Once situation changes preferences change o i e New Years Resolutions we make long term goals for self improvement but they usually do not last very long because short term preferences get in the way Use commitment devices to ensure they are fulfilled Governments Investments Investors want low taxes low levels of regulation minimal oversight o Do not want policies to be rapidly and frequently changing Politicians preferences change bc of circumstances o i e Bush promised he would not raise taxes during his presidency recession taxes increased Politicians can flat out lie Overcome Commitment Problems 1 Delegate Frequent overturn of leadership especially in democracies those who made previous commitments leave office try to set long term policy while they are in office renegotiation proof o Hand over enforcement of commitment to a third party who does not share the preferences of those involved i e Impartial courts o Problems for governments bc many times the govn t is the third party enforcer A state strong enough to enforce is also strong enough to violate o i e Independent central bank no political ties helps maintain a stable rate of inflation 2 Reputation o i e Independent judiciary convinces citizens that rights will be protected o Difficult at the international level o i e Companies strive to maintain a good reputation to keep customers o i e Politicians who are the worst at breaking promises will be unpopular with constituents o Politicians face audience costs 3 Make reversal difficult or impossible o Burn bridges behind you burn your ships cut off your exit o Cut communication Institutional Constraints By virtue of how policies are made policies can be more or less credible 1 Checks and balances o i e Veto points 2 Coalition governments multiparty system o One party is big enough to form the government o Minority party party runs the govn t without being the majority o In Coalition govn ts and minority party govn ts another party has to also sign the bill Partisan veto moderates policy makes it difficult to pass laws laws that are past are very moderate 3 Gridlock Govn ts with gridlock coalition govn ts are more attractive to investors bc the rules may not change very much Information Markets November 6 2012 6 Akerlo The Market for Lemons Quality Uncertainty and the Market Mechanism Wheelan Economics of Information Information Markets No such things as perfect information There are barriers to information i e trustworthy business partners Information Problem Example Market for Lemons Seller knows more than buyer about product or service New vs used cars and good vs bad cars lemons Good and bad cars are priced the same sellers want to sell the bad cars for as much as the good cars o Customers cannot distinguish good cars from bad cars because priced the same o Incentive to sell good car decreases sellers of good cars leave the market market left with lemons consumers assume that all cars left are lemons and no one wants to buy market potentially collapses Markets fundamentally depend on good information otherwise collapses Information Asymmetry The core of the information problem 1 Adverse selection problem of hidden information before transaction o i e Insurance the people buying it are those who are more prone to illness the type that insurance companies do not want o i e Hope Scholarship only attracts low income people unsustainable o i e Banking credit reports o i e Physicians and mechanics consumers are concerned that the procedures parts recommended are those that are the most expensive o i e Politicians the