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March 29, 2009

Watching the way politicians have been behaving recently, during the economic crisis and during all of the ensuing bailouts and bonuses, and related controversies and dramas, one wonders how exactly anything positive can come out of Washington politics.  Of course a lot of boring things that keep the country chugging along do happen on a regular basis (just keep watching CSPAN).  But for anything that hits the public eye (from one off issues such as bailouts and bonuses, to ongoing themes such as taxes and health care), the disingenuous politicking becomes so extreme that any sort of parody is superfluous. But are “politicians” really to blame?

In a previous post on incentives, I described how compensation structures at financial (and other) firms can create perverse incentives that lead to unsurprising outcomes — firms seek short term profit and take excessive risks at the expensive of long term profits and sustainability.  A recent New York Times article, in discussing this principle, cites a 16-year-old academic paper, “Looting”, that describes how the implicit belief that the government would bail out any sufficiently critical financial firm from going under, led to excessive risk taking by investors at those firms.  They kept the gain, sticking the government with the pain.  In the case of financial firms and other public companies, the deleterious decision-making can generally be traced to perverse financial incentives.  In the case of politics, however, the problem is even worse: perverse incentives tightly coupled with adverse selection.

Consider for a moment the incentives driving a politician.  They are numerous, but certainly include:

  • Civic duty – the politician wants to do what is best for his constituency and the country
  • Money – the politician wants more money (or it’s equivalent in the form of perks)
  • Power – the politician wants power (to secure money/perks for his friends and family)
  • Desire to get reelected – the politician wants to do what it takes to ensure he gets reelected, so that he can continue to benefit from the other incentives above

That last incentive — the strong desire to get reelected — is often times the worst offender in terms of distorting a politician’s decision-making process. Ideally, we want politicians to only be driven by the first incentive above — we (the principals) want our politicians (our agents) to be aligned with our collective interests.  The desire for money and power for personal gain are unavoidable, and as long as they are kept in check (through transparency), perhaps not too unwieldy.  But the desire to get reelected is extremely powerful, since it is effectively basic survival as a politician, and causes the politician  to seek large contributions from special interests and wealthy companies and industries, thus becoming at least partly beholden to them. Although this effect is obvious to everyone, and leads to completely undesirable (from the perspective of the public good) policies at times, it is very hard to fix.  We have no way of knowing for sure which incentives are driving a particular politician’s decision making.

A politician with strong “moral” convictions may draw boundaries as to what they are willing to say and do to get reelected, and may continue to have their decision making dominated by their sense of civic duty.  They might seek and accept large campaign contributions, but remain steadfast in voting based on what they think is best for their constituents.  But any “moral” restriction a politician places on his behavior with respect to getting reelected disadvantages him.  (Consider that the truly amoral politician has more tools at his disposal to get reelected — even mimicking a moral politician is a tool open to him).  And now we see the perfect storm underpinning the subtle yet pernicious corruption that results in the dysfunctional political system: the very people most affected by the perverse incentive caused by the desire to get reelected are the ones who actually do get reelected.  The high-minded politicians with strong ethics and morals are the ones weeded out of the system, because they can not raise enough money, or make enough friends, or manipulate public opinion with enough half-truths and misdirection.  If the only problem with politics in Washington was the existence of perverse incentives, we might still expect to reach some workable equilibrium, where politicians got their fixed cut of money and power, in return for (mostly) working for the public interest.  If the selection were decoupled from perverse incentives, then we would still hope to see common sense rather than demagoguery permeate the halls of political power.  But with perverse incentives coupled with adverse selection, we end up with a one-way street to the bizarre state of affairs we see in Washington today.

In the interest of brevity, I’ve glossed over a number of subtle, yet significant points.  I hope to revisit them in future posts, but they include:

  • What exactly is civic duty?  In an ideal world, whose interests should the politicians’ interests be aligned with?  His local constituency?  The country as a whole?  What are the tradeoffs between the two?  (Game theory can shed some light here on the pitfalls and solutions for aligning incentives)
  • Although we only touched on the negative aspect of the wanting to get reelected, the desire for reelection is supposed to be a positive incentive.  It is supposed to keep politicians in check and is supposed to be the tool to actually align their interests with our interests.  (That’s the whole point of democracy.)  How can we achieve the positive aspect of this incentive, and avoid the perverse effects? (Is transparency the key?)
  • How do term-limits factor in?  Is a lame-duck president for instance more able or less able to advance the public’s interests?

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