The microeconomics of governance: the principal-agent-subagent problem

Most (perhaps 98 per cent) of the economists across the world have a blind spot: the economics of governance. And 100 per cent of Indian economists have that blind spot.

This is not about the supply of public goods. 

This is about public choice theory, but about a branch of public choice theory which either does not exist, or so rarely impinges on the public mind that it almost doesn’t exist.

General public choice theory has some excellent analysis. It is, however, not sufficiently well developed in terms of the analysis of the specific institutions of governance found in different parts of the world, and why they perform so differently.

Chapters 4 and 5 of Breaking Free of Nehru contain an elementary discussion on the microeconomics of the main governance institutions in India. The analysis involves consideration of the costs and benefits of various actions on the parties involved (politicians/ bureaucrats). 

My slides for prepared for the 2013 governance reforms conference  are part of this branch of microeconomics. My talk at that conference summarises key aspects of the microeconomics of governance:

Much of Arthashastra by Chanakya contains the microeconomics of governance (although he tends to present the conclusions of his analysis, not the underlying argument).

There is a bit of the microeconomics of governance in the new public management literature, as followed in countries like Australia and New Zealand. 

In brief, this branch of economics is about understanding how the citizen (principal) can get the bureaucrat (his sub-agent) to do what he wants through his agent (politician).

This involves similar principles to the standard principal-agent problem, but because of the vastly greater information gaps, uncertainty, measurability issues, etc. involved, this is a more difficult problem to resolve than the more simple principal-agent problem typically considered in the field of management. There is far more gaming, far greater moral hazard, far more costs of monitoring and enforcement, than in a simple private sector principal-agent problem.

There are also issues regarding the social contract (which I’ve addressed in Discovery of Freedom). – on which far more work has been done by economists in the recent past.

I must say that practitioners of public administration in the West have largely understood the basics of this branch of economics, as a result of which they have designed largely functional institutions. But perhaps Singapore outdoes all of them in the depth of understanding displayed. 

Time permitting, one day I’ll write a text book on the microeconomics of governance. Without understanding it, no one can deliver public goods at an efficient cost.