The Principal-Agent Approach to Politics: Policy Implementation and Public Policy-Making

doi:10.4236/ojps.2013.32012

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Open Journal of Political Science

2013. Vol.3, No.2, 85-89

Published Online April 2013 in SciRes (http://www.scirp.org/journal/ojps) http://dx.doi.org/10.4236/ojps.2013.32012

The Principal-Agent Approach to Politics: Policy Implementation

and Public Policy-Making*

Jan-Erik Lane

University of Freiburg, Freiburg im Breisgau, Germany

Email: [email protected] om

Received December 29th, 2012; revised February 12 th, 2013; accepted March 7th, 2013

bution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the

original work is properly cited.

The principal-agent models may be employed to elucidate central problems in interaction between prin-

cipals and agents in both policy implementation and public policy-making concerning performance and

remuneration. One then hits upon the double principal-agent relationships that are typical of the policy

cycle, from policy-making to policy implementation and back: 1) government as principal for agents in

public service delivery; 2) the population as principal for political agents under various forms of rulership.

Keywords: Principal-Agent Interaction; Asymmetric Information; Moral Hazard; Adverse Selection;

Bureaucracy; New Public Management; Rule of Law; Long-Term Contracting; Short-Term

Contracting; Looting

Introduction

In a world of politics based upon perfect and symmetric in-

formation, an imaginary world of politics along Downs’ 1957

well-known model of two-party system competition in a presi-

dential type re gime, the de mos as principal would contract with

the correct politicians as agents, promising the making of the

policies that majority group in the principal favours. Politicians

would be paid a decent salary, somehow above their fixed res-

ervation price. But there would be no need for rents or qua-

si-rents. Politicians who performed better in terms of a goal like

for instance affluence or GDP growth would be favoured ahead

of politicians who performed badly, the re-election mechanism

doing the selection of agents for the demos.

Given perfect knowledge, voters would pick political agents

on the basis of the proximity rule, minimising the policy dis-

tance between their own political preferences and those of the

politicians in government and the legislature. Thus, radical

left-wing leaders like Lenin, Stalin or Mao would not be chosen

in free and fair elections, when the electore would know about

their hidden agenda. Ringht-wing leaders like Hitler, Mussolini

and France could only for chosen in the first election before

their hidden agenda had been revealed to the population, hav-

ing then experience the empthiness of national chauvinism.

Principal-agent games under perfect information would re-

semble the referendum democracy or a representative regime

with imperial mandates. In a two-party system in Downs’ mod-

el, the principal would elect the agents they want, pay them in a

straightforward manner as well as receive the policies they

prefer. With no rents, opportunism would not work. Besides,

one may assume that politicians in these games are driven by

vocation, as with Max Weber’s model of the ideal agent politi-

cian.

The same—first best solution or perfect equilibria—would

be found in the implementation of policies under perfect and

symmetric information. The government as principal would

hire a set of bureaux to do the job, i.e. provide a set of public

services. These bureaux would be paid a decent remuneration,

hired on long-term contracts with promise of predicatble pen-

sion in order to make sute they develop expertise on policy

matters. Given a sharp distinction between policy-making and

policy implementation, the bureaux would focus their attention

upon the means to achieve goals, maximising efficiency and

effectiveness in policy technology as well as neutrality in poli-

tics, along lines suggested by Weber’s ideal-type model of the

bureaucracy.

The introduction of asymmetric information changes all of

this, allowing for the search for rents or quasi rents by agents

engaging in opportunism.

The Principal-Agent Model

Two conspicuous features in the politics and policy-making

in the early 21st c en t ury include:

1) Policy implementation: The increased externalisation of

public services provision;

2) Policy-making: The increasing call for clean politics and

restraints upon politicians.

The first is linked with the success of the NPM reform

movement, which was based upon a critique of the classical

model of bureaucracy of Weber (Weber, 1978: pp. 956-1002),

whereas the second involves a rejection to the ideal model of

the politician, also launched by Max Weber in “Politics as a

vocation” (Weber, 1991: pp. 77-129). Both of these major

events in politics today may be analysed in terms of the per-

spective upon politics and policies launched by the princi-

*This article is based upon a talk at the University of Haifa with the

School of Political Sciences

November 2012.

J.-E. LANE

pal-agent model. It asks pertinently:

1) Which agents are to be employed in policy implementa-

tion?

2) Can politicians as agents of demos be trusted, under what

rules of the game?

The principal-agent model identifies two major difficulties

when a principal contracts with a set of agents under asymmet-

ric information, namely moral hazard (hidden action) and ad-

verse selection (hidden knowledge). These two difficulties sur-

face whether the contract is explicit and enforceable in court, as

with policy implementation, or the contract is opaque and only

enforceable to a limited extent, as with politics.

The principal-agent model has been applied in various pri-

vate sector settings, such as the remuneration of CEOs, the

choice of contracts in agriculture and the client-lawyer interac-

tion (Rasmusen, 2006). When it is applied to politics, then one

must model a double principal-agent interaction, starting

backwards with first the government choice of agents who will

handle the provision of services and moving then to the choice

of the electorate of political agents with different policy pref-

erences.

The most simple principal-agent model analyses the interac-

tion between a risk prone principal and a set of risk avert agents,

where the former hires the latter on the basis of a contract in-

volving work effort, salary plus perks involving a basic quid

pro quo, whereby the agents are paid from the value of the

output they deliver. The agents may deliver low or high effort,

which has implications for the probabilities of low or high out-

put. As the principal aims for high output, he/she wants to write

a contract that elicits high effort. But all contracts are subject to

two basic principles that must be satisfied: the reservation price

of the agents on the one hand and incentive compatibility on

the other hand. With perfect information one may calculate first

best solutions that satisfy these requirements. However, given

asymmetric information—hidden actions and hidden knowl-

edge, one has to face suboptimal solutions. They are actually

well-known in the literature on bureaucracy and comparative

politics, although the language of the principal-agent model has

not been used.

The Niskanen model of bureaucracy with the public choice

school is a principal-agent model where the agents employ their

information advantage to supply a non-optimal level of public

services. In non-democratic politics, the rulers monopolize the

benefits in politics, sometimes reducing the population to a

form of political slavery (Burma), but always restrict the choice

of the electorate, in order to make looting easier. The opposite

solution, exploitation, is also feasible, for instance in agricul-

ture with powerful landlords (zamindars) employing indentured

labour or controlling sharecropping contracting (McLane,

1993).

Between these two extreme solutions, exploitation by the

principal versus looting by the agents, one finds all kinds of

varying solutions concerning both the value produced and the

division of the mutual gains from interaction. The output can be

either private or public services and the value of the output may

be calculated with market prices or the willingness of tax pay-

ers to pay. One application of the principal-agent model was

less focussed upon rent seeking and targeted more prestige. The

public choice model of public regulation claimed that it had a

fundamental credibility problem, as regulators would like to

deviate from the original policy intentions behind regulatory

schemes.

Below, we focus upon the struggle between the principal and

the agents about the division of the monetary gains from coop-

eration. When agents are self-centred and do not refrain from

opportunism with guile, then what strategies can they employ

in order to get an extra payment using asymmetric information?

Agency Costs

The population as principal has to carry two kinds of agency

costs. First, there is the remuneration of political elites, both

pecuniaty and non-pecuniary. The direct costs may go very

high in non-competitive regimes, as looting is much more

probable in them. Second, there are the indirect costs from dire

agent performance or mistakes, which could go as high as the

complete loss of huge national assets or political territory. Po-

litical leaders may promise paradise on Earth, but accomplish

only destruction. “Mission accomplished”, declared President

Bush, only to have to face the strong insurrection in Iraq that

costs so much in terms of peoples’ life, American causalties

and misspent trillions.

First, politicians wish to have discretion on policies in tela-

tion to their voters, which is what asymmetric information pro-

vides. Thus, they claim that they have a general mandate from

the population to search for the policies that are in the national

interest. Politicians have their own agenda, open or hidden. The

election contract tends to be little specific, often general or

ambiguous. It is a fundamentally incomplete agreement, al-

lowing the politicians as agents much space to maneouvre in

relation to unforseen circumstances, or the contingencies. The

politicians may set up a multi-party system, which would make

coalitions possible beyond the horizon of their voters.

Given such opaque election contracts, the politicians would

wish to amass consierable amounts of resources to allow them

to operate freely, either as parties (partitocrazia) or as in-

depenents (political entrepreneurs). And they would wish to

maximise the resources for the conduct of their business, either

by state contributions to parties (Europe) or by means of soci-

ety contributions through e.g. the PAC system in the US. These

resources—spolia—will be used to remunerate or give favours

to the people who helped them win elections, using massive

propagande to convince the principal about their suitability as

political agents. Thus, party government emerges with massive

rent seeking where the political elite has a formidable knowl-

edge advantage over the population.

Second, under asymmetric information the implementation

agents will embark upon various opportunistic startegies that

increase their remuneration, pecuniary or non-cuniary ones.

Thus, bureaucracies and public enterprices exploit the budget

maximising strategy-shirking. The move of government to New

Public Management, i.e. tendering/bidding under a regime of

short-term contracts, will stop moral hazard in the public sector,

but it invites adverse selection as agents bid who are not trust-

worthy or reliable . Managing tournaments and auctions will be

as difficult as to monitor huge bureaux for government as the

principal of the public sector.

Agency costs, like e.g. the spoils of competitive politics are

motivated by the classical Burke theory of politicians as the

guardians of the general interests of the principal. But who

knows the true interest of the population—asymmetric infor-

mation?!

Sometimes the rent-seeking ambitions of political agents

lead them to eng age in illegal activiti es :

J.-E. LANE

 Patronage,

 Embezzlement,

 Corruption;

 Tax evasion;

 Kick backs and commissions on public contracts.

An economic rent is an unearned income, meaning an exces-

sive remuneration compared with what had to be paid, or it is a

payment in excess of the opportunity cost. The theory of eco-

nomic rents has concentrated upon monopoly profits, collusion

gains from oligopolistic competition, as well as rents for lob-

bying government to secure lucrative contracts or favourable

regulation (Tullock, 2005). Rents figure prominently in princi-

-pal-agent interactions, whether as pecuniary or non-pecuniary

advantages. The nature of the political regime—its basic struc-

ture of public law—affects how political agents maximise the

rents.

Non-Competitive Regimes: In a traditional or authoritarian

regime, like Saidi Arabia or North Korea, political agents tend

to take such a huge part of total output (GDP) that one is al-

lowed to speak of looting. Thus, the remuneration of the large

Saidi fami ly is immense, co mprising all kinds of income , perks

and capital assets, home or abroad. In North Korea, the entire

country has been mobilised to provide favours and advantages

to the clan of the ruling family. Charismatic regimes like the

Maoist rulership in China involve enormous agency costs, both

direct in supporting Mao and his entourage, as well as indirect

ones, resulting from mistaken policies.

Competitive Regimes: The agency costs for political regimes

that have open access tend to be much lower than those of

closed regimes. Thus, when political agents cause costly mis-

takes to the population, they will probably be voted out of of-

fice. However, also competitive regimes run with economic

rents for the politicians.

Politicians or political parties have an unsatiable need for

resources in order to maintain themselves and their advanta-

geous positions in society, as there are considerable costs of

competition. Thus, they employ all kinds of ways to bolster

their coffers: high salarier for representative positions, political

appointments in the bureaucracy, campaign contributions,

“cumul des mandates”, close connections with support groups

(industry, labour, and agriculture), public contributions to

newspapers affiliated with parties, subsidised educations

courses by affiliated orginisations, tax reductions for trade un-

ion fees and payments to think tanks, etc.

Value of Output, Remuneration and Rent

The agents hired by the principal to deliver a valuable output

must of course be paid somehow for their work and effort. The

payment of the agents comes out of the value of the output,

either directly through market prices or indirectly through taxa-

tion and public fees. All other things equal, the agent wants as

large remuneration whatever its forms as possible whereas the

principal remains the residual claimer, thus being interested in

maximising the difference between the value of output—agent

remuneration.

What the agent is paid in pecuniary and non-pecuniary forms

of remuneration depends upon their effort, the reservation price

and incentive compatibility, given asymmetric information.

The occurrence of conditions for moral hazard or adverse se-

lection opens up for strategies of opportunism on the part of the

agents, attempting to get hold of an extra remuneration, a

so-called rent in economic theory. Long-term contracting in-

vites the option of shirking, whereas adverse selection provides

for opportunities of pretending.

Policy Implementation: From Moral Hazard to

Adverse Selection

The NPM (New Public Management) revolution in public

administration emerged from a background of weariness with

big government, public deficits and government overload in the

mature welfare state. Intellectually, it was much inspired by

public choice theories, especially their criticism of long-term

contracting, as with bureaucracy and the public enterprises.

Both bureaucracy and the public enterprise were institutional

mechanisms that invited one key strategy from the agents,

namely shirking. Given asymmetric information, government

would be in a weaker position, having to take whatever cost

increases the bureau or public enterprise came up with. Both

the bureau and the traditional trading department captured an

excessive remuneration by expanding activities beyond what

was optimal, resulting in excessive number of employees and

costs. In reality, there was here a form of moral hazard, as the

risk ended up one-sidedly with government whereas the bene-

fits would be mostly with the bureau or public enterprise. In

long-term contracting, promises are cheap, and memory is short

concerning what was promised when outcomes turn up that are

undesirable.

NPM recommended short-term contracting as a strategy to

strengthen the position of the principal in relation to the pro-

viders of public services. Instead of bureaucracy and the tradi-

tional public enterprise, the principal would apply the following

mechanisms suitable for short-term contracting:

1) Outsourcing;

2) Tournaments;

3) Auctions;

4) Incorporation.

All these mechanisms involve the employment of tender-

ing-bidding that replaces the authority structure with the capac-

ity of government to exercise authority over its bureaux and

employees. Government gives up its power to plan and direct

the agents responsible for policy implementation in order to

buy specific services in accordance with a private law contract,

specifying performance as well as quantities and quality. The

public law governed budgetary process is undone, as the pri-

vate law contract is supposed to cover the most relevant con-

tingencies, including costs and service quantity and quality.

Government becomes a contractor, employing private law to

arrange for the provision of services. Public ownership is

transformed through incorporation into the holding of assets

through aktien, i.e. a private law institution. Government hires

agents to manage its capital assets in accordance with private

management principles, focussing upon rentability in the first

place.

The move from long-term contracting to short-term con-

tracting entails that government has to struggle with the prob-

lem of adverse selection, i.e. how to figure out which agents

who are forthcoming to bid for all the government contracts

can be trusted. Government is bound to run into massive trans-

action costs when it moves from bureaucracy to tender-

ing-bidding, as conflicts arise about what has been agreed upon.

Contracting presupposes considerable time and effort for nego-

tiation and may involve substantial costs for enforcement as

J.-E. LANE

well as dispute settlement in courts or outside.

Nothing guarantees that government will be able to reduce

its overall costs or increase performance in service delivery,

when moving from long-term contracting to short-term con-

tracting. Just as a number of strategies can be used by agents to

shirk under long-term contracting arrangements, so alternatives

ways for agents to engage in opportunism exist under short-

term contracting, all allowing for agents to pretend they are

better than they really are. It may indeed be costly for govern-

ment to correct these pretending strategies, incurring switching

costs when turning to another set of agents or being forced to

pay more for unforeseen costs besides loosing court cases

where agents exploit badly written contracts.

The principal and the agents have common interests in the

agents delivering a big output of value, but agents will only try

hard when incentive compatibility is met by the principle.

Nothing prevents the agent from demanding a huge remunera-

tion for pretending high effort, i.e. to engage in the opportun-

ism of looting. When the traditional public enterprise is incor-

porated and deregulated, then the temptation of the looting

strategy may be irresistible. Thus, with incorporation the num-

ber of employees goes down and profits go up, but the salaries

of the key CEO:s tend to skyrocket, especially when large pub-

lic corporations turn to regional or global strategies outside of

the home country.

Policy Implementation: Hidden Actions and Adverse

Selection

When governments set out to deliver a set of public services,

they have to rely upon sets of agents. The classic model of

public administration outlined a set of bureaux with specialised

functions, accumulating expertise over time. However, under

long-term contracting agents have incentives to capture a rent

due to asymmetric information. This rent from shirking may

consist of X-inefficiencies or merely too much employment.

The controller of the bureau—the Ombudsman—would inves-

tigate the occurrence of hidden actions among the agents, i.e.

violations of the public law framework of bureaucracy.

Public sector reform during the last twenty years has turned

to short-term contracting to remove this rent, favouring exter-

nalisation of the delivery of public services, including the in-

corporation of the big public enterprises. However, with ten-

dering-bidding and short-term performance contracting come

adverse selection, which provides the agents with another type

of opportunistic strategies in order to capture a rent from pre-

tending. The principal has to assume considerable transaction

costs in order to handle the implications of adverse selection

Policy-Making and Asymmetric

Information

The agency problems involved in hidden action and hidden

knowledge characterize not only the implementation of policy,

but they figure prominently also in politics as policy-making:

Can the demos as principal trust its politicians as their agents

for the making of public policies?

The distrust in political elites was theorized in the so-called

elite theory with the three Machiavellians: Pareto, Mosca and

Michels. They argued that politicians develop their own agen-

das in order to promote their special elite interests, capturing a

rent by means of opportunistic strategies.

Elite theory was much criticised by pluralist theory, mainly

by means of the argument that political elites tend to be plural-

istic in terms of both origins and composition. However, this

counter-argument does not take into consideration that political

elites from various backgrounds—social and ideological, en-

gage in hidden actions and employ hidden knowledge to in-

crease their remuneration in a broad sense of the term, covering

both pecuniary and non-pecuniary rewards.

Moral hazard pocketing any favourable outcomes—merely

luck, while placing the risk with the country or blaming

—unforeseeable negative results—occurs often in politics.

Similarly adverse selection is omnipresent, especially in elec-

tions where the demos has difficulties in evaluating electoral

promises as realistic or unrealistic ones. The rationale of con-

stitutionalism in politics derives from its contribution to undo

asymmetric information, revealing hidden actions and hidden

knowledge among the political elite.

Thus, the mechanisms against political opportunism are

handed down in the theory of rule of law, including:

1) Judicialisation of politics;

2) Referendum and recall;

3) Parliamentary opposition;

4) Federalism or political decentralization;

5) Civil society involvement;

6) Re-election of politicians: limits on tenure, primarie s, etc.

Constitutional democracy consists of a number of institutions

that counteract the implications of political elitism. These in-

stitutions divide up the set of political agents into competing

sets with the consequences that asymmetric information is re-

duced considerably for the demos. Opportunistic strategies

based upon hidden knowledge—bad politicians—or hidden

actions-illegal manoeuvres—trigger responses or counter

strategies. In a rule of law regime, bad politicians are—some-

times at least—eliminated and illegal practices punished. More

specifically, public law restrains the solutions to the princi-

pal-agent problematic through the following: Predictability:

Public law when properly implemented makes it possible for

people to increase the rationality of behaviour. They know

what rules apply, how they read as well as how they are applied

consistently. This is very important for the making of strategies

over a set of alternatives of action.

Transparency: Societies operate on the basis of norms pro-

hibiting, obligating or permitting certain actions in specific

situations. Rule of law entails that these norms are common

knowledge as well as that they are not sidestepped by other

implicit or tacit norms, known only to certain actors.

Due Process of Law: When conflicts occur either between

individuals or between persons and the state, then certain pro-

cedures are to be followed concerning the prosecution, litiga-

tion and sentencing/incarceration. Thus, the police forces and

the army are strictly regulated under the supervision of courts

with rules about investigations, seizure, detainment and prison

sentencing. No one can take the law into their own hands.

Immunities: People have certain rights against the state,

meaning that government faces definitive duties concerning the

protection of life, personal integrity and property. One may call

them the habeas corpus rights.

Counter-weighling Powers: Under the rule of law regime

there could be no single source of political power, or a hierar-

chical order of command. Instead, it favours multiple centres of

power, or pluralism. In terms of religion, it adheres to a secular

state based upon religious tolerance.

J.-E. LANE

Separation of Powers: In order to have respect for the law as

the key instrument for governing society and regulating the

state, legislation, policy-making and implementation as well as

law adjudication must somehow be separated. Under rule of

law this separation of powers targets the political elite active in

the state, with the claim that it has to be divided into three dif-

ferent elites: legislators, governors or governments and courts.

These classic functions in the state cannot be exercised by one

and the same set of political elites. Separation of powers en-

hances checks and balances ingovernment as well as counter-

weighing powers.

Fairness: Public law comprises a number of mechanisms

that promote not only the legal order, or the law, but also jus-

tice, or the right. For ordinary citizens, the principle of com-

plaint and redress is vital, providing them with an avenue to

test each and every decision by government, in both high and

low politics. Here one may emphasize the existence of the

Ombudsman, as the access to fairness for simple people.

Conclusion

Politics is both policy-making and policy implementation.

The demos selects and instructs a set of agents—the politicians

—to come up with a list of policies that the demos prefer. Yet,

the politicians do not have time or expertise to put these poli-

cies into practice, which is why they—as principals—rely upon

a set of agents to deliver public services. Thus, one arrives at

the double nature of principal-agent interactions in politics.

One may interpret the move from bureaucracy to New Public

Management as the search for strategies that reduce the asym-

metric information advantage of bureaux. NPM helps against

shirking but invites another form of opportunism, namely pre-

tending. Adverse selection is not a major problem in long-term

contracting, as the principal has a general authority to direct the

work of the agents. But in short-term contracting, the selection

of bad agents can only be corrected by high transaction costs,

as failure to fulfil a contract will often be contested in court.

Shirking may of course also occur in short-term contracting.

The huge attention given to political scandals in present day

politics fits well into a principal-agent approach to elections

and policy-making. Politicians as elite have incentives to cap-

ture a rent by means of all kinds of opportunism. Only the rule

of law regime can counteract the consequences of hidden ac-

tions and hidden knowledge.

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