What Is the Principal-Agent Problem in Government?

The principal-agent problem describes challenges that occur when agents and principals have conflicting interests. Democratically elected governments are common in developed economies. These nations are often governed as direct democracies or republics that operate by allowing citizens to choose government officials. These officials are agents of the people they represent. Does the government truly represent the people?

KEY TAKEAWAYS

  • The principal-agent problem can occur in government when officials have incentives to act in their own interests rather than as agents for the people, who are the principals.
  • Elected officials, unelected officials, and lobbyists all face different pressures to act against the public interest.
  • Sometimes, principal-agent problems occur because government officials lack the knowledge to act effectively as agents for the people.
  • Principal-agent problems in government can be reduced by changing incentives to minimize conflicts of interest.

Elected Officials

The people, who are the principals, want officials to make decisions in their best interests. Perfect agents with perfect information would act to serve them. That would be true even when the people's interests conflicted with their own. Consider the example of U.S. President George Washington. Washington was one of America's largest producers of whiskey. However, he suppressed the Whiskey Rebellion, which was directed against a tax on whiskey. Whenever government officials act in their own private interests, they potentially introduce conflict into their relationship with voters. In theory, elections ultimately provide a check on elected officials who go against the public interest.

Unelected Officials

According to their supporters, unelected civil servants can work toward the public interest more effectively because they do not have to worry about the next election. In this view, the administrative state is a meritocracy where the best and the brightest work for the common good. If civil servants act against the public interest, then they can be dealt with appropriately without partisan political protection.

The opposite view is that unelected bureaucrats are unaccountable to the voters and act in their own interests. According to economist William Niskanen, the goal of bureaucrats is to maximize their own budgets rather than general social welfare. If this view is correct, then unelected administrators have a conflict of interest with voters. Unelected officials, especially those who are difficult to fire, would seem to have chronic difficulty acting as agents for the people.

Corporate Lobbyists

There are more issues when businesses begin interacting with government representatives. One problem is the potential conflict between the benefits of competitive markets and corporate lobbyists drafting industry regulations. Large firms have departments tasked with interpreting and applying government policy. Many of the staff hired for these departments have public sector experience. They may return to government work in the future. The result can be regulatory capture, in which regulators come under the control of the corporations they are supposed to be regulating.

For these staff members, there is little incentive to keep regulations simple while in public service. The best interests of the businesses they occasionally work for conflict directly with the interests of the people. In this sense, some people believe that corporate government relations departments act against competitive markets and the public.

On the other hand, there is a strong technocratic argument in favor of lobbyists. Principal-agent problems can also occur because of asymmetric information. The government may create unrealistic and impractical regulations simply because elected officials have limited knowledge of the workings of the economy. By accepting input from lobbyists, government officials can learn what is possible. For example, automotive regulations, such as fuel economy standards, are heavily influenced by the knowledge of people working in the industry.

Incentives

According to agency theory, addressing principal-agent problems requires realigning incentives. If officials stand to benefit from employment opportunities with private firms as a direct result of increasing industry regulation, then the rules must change. Popular election of representatives may only partially address this problem by leaving officials free to act in their own interests after the election. Public employees also often stand to benefit from creating more regulations, producing a potentially significant conflict of interest.