Answer PLSC COMP 1

How do institutions affect principal-agent relationships in government?

=GMs Outline=

General Theory of Delegation
Delegation is a rational response to collective action problems. But delegation creates the opportunity for the agent to act in ways counter to the principle's interests. This is agency loss. (See Kiewiet and McCubbins 1991 Logic of Delegation)

Economic Underpinnings of Institutions

 * Coase's Theory of the Firm (1937) argues that firms come together in order to internalize transaction costs associated with re-negotiating contract after contract. Coase Summary


 * Akerloff (1970)(The Market for Lemons). Under market conditions of imperfect information, the presence of inferior goods destroys the market for quality goods.  High quality sellers need a way to signal their products' worthiness.  Options: guaranties, warranties, iterated transactions (brand name products), consumer reviews and certifications, etc.  Akerloff Summary


 * Alchian and Demsetz (1972)Alchian and Demsetz Summary Unlike Coase, Alchian and Demsetz believe that it is information costs, rather than transaction costs, that gives rise to firms.  His argument: Sometimes teams can be more efficient and productive than individuals working separately.  But, when you organize as a team to share the burden, incentives to shirk arise.  What you need to prevent shirking is a system of monitoring.


 * Fama (1980)(Agency Problems and the Theory of the Firm). Fama Summary  A response to Alchian and Demsetz (1972).  Fama wants a theory of the firm that, unlike Alchian and Demsetz, removes the enterprise owner.  In essence we want to hire someone to do the policing for us.  So Fama divides ownership of capital from the managerial force (think of this like shareholders in a company and the executive officers who run the day to day activities of the corp.  In fact, this is exactly the reason for corporation law).  The competition for both capital and management will keep both in check.

North and Weingast

Government Institutions
Courts: the appellate system is a way for higher courts to strategically audit inferior ones. (Cameron, Segal, Songer 2000)

All of the delegation literature goes here.


 * Kiewiet and McCubbins, dealing with Congress, address four ways for Congress to overcome agency loss.

1. Contract design (ex ante, to prevent moral hazard)

2. Screening and selection mechanisms (ex ante, to prevent adverse selection)

3. Monitoring and reporting requirements (ex post, but these are costly and can be manipulated by agents; monitoring takes the form of police patrols (random audits) and fire alarms (by affected third parties))

4. Institutional checks (ex post, like checks and balances). Institutions can be sticky or not.

K&M stress that delegation is not an act of abdication of authority (a la Niskanen).


 * McCubbins, Noll, and Weingast (1987) look to administrative law as a means for politicians to control the bureaucracy. Summary