Rethinking the Welfare State: The prospects for ... - e-Library

Rethinking the selfare state 20
either or both parties—the provider and the consumer—to produce or consume
efficiently. The lack of innovation in the menu of public services can also be seen as a
consequence of the failure to provide adequate contractual incentives for innovation, as
well as of the very structure of certain contractual arrangements, as for example in
situations where the precise terms of service provision must be negotiated ex ante and
cannot change to meet the actual preferences of consumers.
Agency costs
There are also a set of challenges called principal-agent problems: scenarios in which
one party (the agent) acts on behalf of another (the principal), such as when a government
(the agent) contracts with a private company to provide services to consumers (the
principals). In such scenarios, problems will arise for two major reasons: it is impossible
for even the most well-informed agent to have complete knowledge of the principal’s
interests and preferences; and the preferences of principal and agent may be divergent,
sometimes radically so. 20 The former problem is sometimes described (most famously by
Friedman 21 ) as paternalism; that is, the arrogation to the agent of the right to decide what
is in the best interests of a rational and self-aware principal who may actually be in a far
better position to discern what is best insofar as his or her own welfare is concerned. The
latter problem can manifest itself in a variety of forms, from the development of policies
which are unpalatable to consumers, to overt conflicts of interest, such as patronage and
bribery.
Modes of accountability
As serious as certain principal-agent conflicts can be, a variety of mechanisms or modes
of accountability operate in both the public and private sectors to align the interests of
principals and agents. These mechanisms become particularly important in scenarios
which are not explicitly covered by the terms of contract. However, these mechanisms
are not all equally effective, and can give rise to agency costs, such as “the cost of
structuring the contract so as to require the agent to perform the desired service as a
proxy for the principal [and] the cost of enforcing the contract.” 22 As Trebilcock
observes, “[d]ifferent organizational arrangements have different inherent incentive
structures that yield different agency costs.” 23
For instance, in organizations with a diffuse body of principals, such as publicly traded
companies with a large number of stockholders, the principals face a problem in asserting
control over the company, since they can only exert pressure on their agent (the
company’s management) by acting collectively. At the same time, however, the “market
for managers” and the fact that the hiring of management is often based on the track
record of candidates with respect to stock performance, can help to align the interests of
the principals and their agents. 24 Furthermore, remuneration in the form of stock or stock
options creates a direct incentive on the part of management to improve the company’s
market performance, and the wealth of stockholders along with it. Public enterprises,
however, are not as directly affected by management markets, and must rely on still other
modes of accountability, with different forms of agency costs.