Investopedia: How is the principle agent problem manifested in the government?

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How is the principle agent problem manifested in the government?

By Investopedia | April 13, 2015 — 3:11 PM EDT
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The principal-agent problem describes challenges that occur when agents and principals have conflicting interests. Democratically elected forms of government are common in many First World countries. These nations are often governed as republics or direct democracies that operate by allowing citizens to choose their own government officials. These officials are agents of the people they represent.

The people, all principals by definition after electing their representatives, assume the officials are making decisions that benefit the best interests of the nation. Perfect agents, having perfect information about these best interests and being motivated to serve the principal, act to benefit the principal even when the principal's interests are in conflict with their own. Members of the public often assume their representatives in government will represent their ideal interests with few problems. Whenever government officials act in their own private interests, they potentially introduce conflict in their relationship with voters.

This challenge occurs with individual voter representation and also with businesses interacting with government representatives. One problem for industry, for example, is the potential conflict between business and hired agents helping to navigate industry regulation. Many firms have departments tasked with interpreting and applying government policy. Many of the staff hired for these departments have public sector experience and may return to government work in the future.

For these staff, there is little incentive to keep regulations simple and minimal while in public service. The best interests of the businesses conflict directly with the interests of their own government relations departments. In this sense, some people believe that corporate government relations departments act against corporate profitability by pursuing objectives that provide little benefit to competitiveness and company performance. Any challenges then would be a result of these staff members having an incentive to act against the company.

In a similar vein, representatives chosen to work in governmental organizations may have a vested interest in acting contrary to voter interests.

According to agency theory, addressing principal-agent problems requires realigning incentives. If officials stand to benefit from increased employment opportunities with private firms as a direct result of increasing industry regulation, then the interests of businesses are not properly addressed. Public choice of representation may only partially address this problem by leaving officials free to act in their own interests after election. Public employees often stand to benefit from regulation, creating a potentially significant conflict of interest for industry.

In the private sector, principal-agent problems are also very common and must be addressed to minimize damage to competitiveness. Businesses concerned about the principal-agent problem may carefully examine incentives that encourage activity that does not generate revenue and explain to their departments how government regulation may impact future profitability for the company.
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