Principal-Agent Theory and the Welfare State

October 14, 2011

Controlling politicians in the welfare state bears resemblance to the principal-agent relationship, but brings with it a host of new problems.  When individual voters (principals) cannot reasonably "exit" relationships with politicians (agents), they often become trapped in inefficient structures.  Holding politicians accountable in a welfare state requires considerable time and effort.  Unfortunately, in a large democracy, the return on any one voter's efforts is vanishingly small.  For this reason, they choose not to exert themselves at all.  This tendency manifests itself as political cynicism and voter apathy, problems that have the potential to cause profound disaster in the future, says Mark Pennington, professor of public policy and political economy at Queen Mary, University of London.

  • For example, in the United States, as many as 70 percent of voters can't name either of their state's senators and the vast majority cannot estimate rates of inflation or unemployment within 5 percent of actual levels.
  • This willful ignorance of the goings on of the government minimizes voter oversight as a factor in politicians' strategic decision-making, enabling political opportunism via lackadaisical job performance and personal ambition.
  • When this loss of oversight is viewed in terms of the debate over the prevalence of entitlement programs, the results become obvious.

While a collective action problem prevents most younger and middle-age voters from taking a strong stand on entitlement programs, the same is not true of the elderly population.  Because they are organized (see AARP), have relatively similar interests and vote consistently, their voices are the most influential in political discourse regarding entitlements.  Furthermore, they overcome the collective action problem because the benefits of the programs (and therefore the costs of losing them) are concentrated, whereas the costs for the rest of the population are diffused.

The result of this perniciously disproportionate influence is a burgeoning entitlement structure that is plagued by fraud.  Politicians, desiring both a leisurely job and a reliable senior voting bloc, choose not to exert the additional effort necessary to rein in the excesses of the system.  Meanwhile, truly good policy for the rest of society is ignored due to lack of mobilization.

While reform suggestions are numerous, at their core should be two principles: first, we must abandon a system in which those who claim future benefits have the ability to dismiss those who finance them.  And second, we must address the fact that those who manage taxpayer dollars have every incentive to favor short-term political gain over long-term sustainability.

Source: Mark Pennington, "Principal-Agent Theory and the Welfare State," Cato Institute, September/October 2011.

 

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