Government as a business

2010-10-06T02:32:00.001-07:00

Every now and then, when the government gets too corrupt and the bureaucracy too complacent, calls to run government like a business become increasingly strident. But can that be accomplished? Is the role of government to turn a profit, to provide services that businesses can't or won't or to fulfill a role that is both undefined and irreplaceable?

It seems that successful businessman make terrible government:

The politics of disastrous management

A striking number of businesspeople prove to be failures as politicians. Paul O’Neill was one of Alcoa’s most successful bosses. But, as Mr Bush’s first treasury secretary, he was rapidly reduced to a laughing-stock. Ross Perot turned Electronic Data Systems into a giant. But his two runs for the presidency left most Americans with the impression that his tray table is not in the fully upright and locked position. Donald Rumsfeld was a successful boss of two big companies. But his name is synonymous with one of the worst-managed wars in American history.

Bringing businesspeople into politics can also produce corruption and cronyism. Russia’s oligarchs flit between government and business. Mr Berlusconi has built conflict of interest into the heart of Italian life. Dick Cheney, a former boss of Halliburton, an oil-and-gas company, made sure his secretive energy task-force relied heavily on his buddies from the energy industry.

This is not to imply that politicians are paragons of either virtue or competence. But the most important thing in politics is structure, not personnel. The best way to inject the virtues of business into public life is not to draft in a few ex-bosses—even outstanding ones like Ms Whitman—but to introduce as much choice and competition as possible into the public sector.

Sources / More info: ec-CApol

Fiat Justitia, government, politics, gov, gov fail

The Principal - Agent or Agency problem

2010-02-22T03:52:00.001-08:00

When retaining a lawyer - or any other professional - to work for you or to represent you, you might think you are solving a problem. And though in the great balance of things you are, there is also another kind of problem creeping in: it is what economists call the Principal-Agent problem.

In a nutshell, this dilemma concerns the “difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent, such as the problem that the two may not have the same interests, while the principal is, presumably, hiring the agent to pursue the interests of the former”. This problem is widespread in our economic and political life, arising in most employer / employee, stockholder / executive, legislative / bureaucracy relationships.

The problem is more or less solved by using one or more of the following “tools”:

piece rates/commissions
profit sharing
efficiency wages
performance measurement (including financial statements)
the agent posting a bond
fear of firing
tough screening processes
incentives for good behaviour and punishments for bad behaviour
watchdog bodies

The above possibilities mean, in terms of game theory, changing the rules of the game so that the self-interested rational choices of the agent coincide with what the principal desires. The auburn.edu document expresses it succinctly:

The more autonomy that agents have to have in order to do their particular kind of work effectively and efficiently, the less useful coercive sanctions are likely to be, and the more important it becomes for agents' moral and material incentives to be appropriately aligned with their broader obligations to their principals. That is, organizations need to be structured in such a way so the agent will expect that diligently serving the interests of his or her principals will also be in his or her own long-run best interests. In order to accomplish this, the principals need to be reasonably clever in setting up the initial rules of the game that are set in the employment contract, sufficiently vigilant in keeping track of their agents' quality of performance over time, and willing to bear at least some minimum level of “agency costs” in order to provide the necessary incentives.

Because the Principal – Agent problem appears in so many fields, the solutions employed must be adapted to each particular instance. In particular, it has been shown that increased (monetary) compensation might have an adverse effect on performance, especially in cognitive-complex endeavours.

This issue was described in the book Freakonomics, using Enron and real estate as examples. The examples may seem extreme, but are nonetheless illustrative of the unavoidably complex web of relationships governing virtually any economic transaction.

During a phone conversation on August 5, 2000, two traders chatted about how a wildfire in California would allow Enron to jack up its electricity prices. “The magical word of the day,” one trader said, “is ‘Burn, Baby, Burn.’” A few months later, a pair of Enron traders named Kevin and Tom talked about how California officials wanted to make Enron refund the profits of its price gouging.

KEVIN : They’re fucking taking all the money back from you guys? All the money you guys stole from those poor grandmas in California?
BOB : Yeah, Grandma Millie, man.
KEVIN : Yeah, now she wants her fucking money back for all the power you jammed right up her ass for fucking $250 a megawatt hour.

If you were to assume that many experts use their information to your detriment, you’d be right. Experts depend on the fact that you don’t have the information they do. Or that you are so befuddled by the complexity of their operation that you wouldn’t know what to do with the information if you had it. Or that you are so in awe of their expertise that you wouldn’t dare challenge them. If your doctor suggests that you have angioplasty—even though some current research suggests that angioplasty often does little to prevent heart attacks—you aren’t likely to think that the doctor is using his informational advantage to make a few
thousand dollars for himself or his buddy. But as David Hillis, an interventional cardiologist at the University of Texas Southwestern Medical Center in Dallas, explained to the New York Times, a doctor may have the same economic incentives as a car salesman or a funeral director or a mutual fund manager: “If you’re an invasive cardiologist and Joe Smith, the local internist, is sending you patients, and if you tell them they don’t need the procedure, pretty soon Joe Smith doesn’t send patients anymore.”

Armed with information, experts can exert a gigantic, if unspoken, leverage: fear. Fear that your children will find you dead on the bathroom floor of a heart attack if you do not have angioplasty surgery. Fear that a cheap casket will expose your grandmother to a terrible underground fate. Fear that a $25,000 car will crumple like a toy in an accident, whereas a $50,000 car will wrap your loved ones in a cocoon of impregnable steel. The fear created by commercial experts may not quite rival the fear created by terrorists like the Ku Klux Klan, but the principle is the same.

Consider a transaction that wouldn’t seem, on the surface, to create much fear: selling your house. What’s so scary about that? Aside from the fact that selling a house is typically the largest financial transaction in your life, and that you probably have scant experience in real estate, and that you may have an enormous emotional attachment to your house, there are at least two pressing fears: that you will sell the house for far less than it is worth and that you will not be able to sell it at all.

In the first case, you fear setting the price too low; in the second, you fear setting it too high. It is the job of your real-estate agent, of course, to find the golden mean. She is the one with all the information: the inventory of similar houses, the recent sales trends, the tremors of the mortgage market, perhaps even a lead on an interested buyer. You feel fortunate to have such a knowledgeable expert as an ally in this most confounding enterprise.

Too bad she sees things differently. A real-estate agent may see you not so much as an ally but as a mark. Think back to the study cited at the beginning of this book, which measured the difference between the sale prices of homes that belonged to real-estate agents themselves and the houses they sold for their clients. The study found that an agent keeps her own house on the market an average ten extra days, waiting for a better offer, and sells it for over 3 percent more than your house—or $10,000 on the sale of a $300,000 house. That’s $10,000 going into her pocket that does not go into yours, a nifty profit produced by the abuse of information and a keen understanding of incentives. The problem is that the agent only stands to personally gain an additional $150 by selling your
house for $10,000 more, which isn’t much reward for a lot of extra work. So her job is to convince you that a $300,000 offer is in fact a very good offer, even a generous one, and that only a fool would refuse it.

This can be tricky. The agent does not want to come right out and call you a fool. So she merely implies it—perhaps by telling you about the much bigger, nicer, newer house down the block that has sat unsold for six months. Here is the agent’s main weapon: the conversion of information into fear. Consider this true story, related by John Donohue, a law professor who in 2001 was teaching at Stanford University: “I was just about to buy a house on the Stanford campus,” he recalls, “and the seller’s agent kept telling me what a good deal I was getting because the market was about to zoom. As soon as I signed the purchase contract,
he asked me if I would need an agent to sell my previous Stanford house. I told him that I would probably try to sell without an agent, and he replied, ‘John, that might work under normal conditions, but with the market tanking now, you really need the help of a broker.’”

Within five minutes, a zooming market had tanked. Such are the marvels that can be conjured by an agent in search of the next deal.

Consider now another true story of a real-estate agent’s information abuse. The tale involves K., a close friend of one of this book’s authors. K. wanted to buy a house that was listed at $469,000. He was prepared to offer $450,000 but he first called the seller’s agent and asked her to name the lowest price that she thought the homeowner might accept. The agent promptly scolded K. “You ought to be ashamed of yourself,” she said. “That is clearly a violation of real-estate ethics.” K. apologized. The conversation turned to other, more mundane issues. After ten minutes, as the conversation was ending, the agent told K., “Let me say one last thing. My client is willing to sell this house for a lot less than you might think.” Based on this conversation, K. then offered $425,000 for the house instead of the $450,000 he had planned to offer. In the end, the seller accepted $430,000. Thanks to his own agent’s intervention, the seller lost at least $20,000. The agent, meanwhile, only lost $300—a small price to pay to ensure that she would quickly and easily lock up the sale, which netted her a commission of $6,450.

So a big part of a real-estate agent’s job, it would seem, is to persuade the homeowner to sell for less than he would like while at the same time letting potential buyers know that a house can be bought for less than its listing price. To be sure, there are more subtle means of doing so than coming right out and telling the buyer to bid low. The study of real-estate agents cited above also includes data that reveals how agents convey information through the for-sale ads they write. A phrase like “well maintained,” for instance, is as full of
meaning to an agent as “Mr. Ayak” was to a Klansman; it means that a house is old but not quite falling down. A savvy buyer will know this (or find out for himself once he sees the house), but to the sixty-five-year-old retiree who is selling his house, “well maintained” might sound like a compliment, which is just what the agent intends.

(…)

It would be naïve to suppose that people abuse information only when they are acting as experts or agents of commerce. Agents and experts are people too—which suggests that we are likely to abuse information in our personal lives as well, whether by withholding true information or editing the information we choose to put forth. A real-estate agent may wink and nod when she lists a “well-maintained” house, but we each have our equivalent hedges.

Don't forget that agents who you may feel have ripped you off, often find themselves in a similar position while interacting with other agents.

Sources / More info: wiki, wiki-info-assymmetry, wiki-principal, wiki-agent, auburn, Freakonomics, wiki-piece-rates, wiki-commissions, wiki-profit-sharing, wiki-efficiency-wages, wiki-performance, wiki-fin-statements, caux-agency, is-theory-biblio, is-transaction-cost, principal-agent-conflict-management, yt-principal-agent-motivation

Fiat Justitia, economics, freakonomics, principal-agent, asymmetric, information, info