Tuesday, June 14, 2011

Incentives, The Agency Problem and the Decline of America

Anti-Virus and Computer Security firms receive a very large ongoing revenue stream for protecting computers and networks from viruses, malware and hackers.  And yet, it goes without saying that this vast river of wealth would quickly dry up if the threats were eliminated, or effectively prevented.

Pakistan receives a large subsidy from the US to fight the threat posed by Islamic militants inside that country.  But if the Pakistanis were to fight these groups TOO effectively, there would no longer be a compelling reason for the US to provide aid at these levels.

The US military budget is by far the largest in the world.  This trillion dollar expenditure supports thousands of quasi-independent fiefdoms, bureaucracies and internal organizations and partnerships.  But they are all dedicated, in one way or another, to fighting wars.  So the only way for any given military-industrial bureaucracy to guarantee its survival year-over-year is to find wars to fight.  What we might see as a "Peace Dividend" they see as an existential threat - for these organizations, peace is something to be avoided.

Banks, insurance companies, governments.  Everywhere we look, we find ourselves trying to solve one problem, only to be confronted by an agency dilemma.  Certainly we're guilty of not thinking creatively enough when making these sorts of arrangements, but we've also seen an evolution of the profit motive - it is precisely through these kind of skewed incentives that rent-seekers produce most of their profits.  When you demonstrate that you are willing to pay someone to solve a problem on your behalf, it is not in that contractor's best interest to solve that problem quickly, or permanently.  This is not a new discovery. The whole point of incentives in the first place is overcome this basic conflict of interest.  But the incentives need to be designed carefully, with safeguards in place to encourage genuine solutions, and not prolonged payments.

If, for example, we told the Pakistanis that were were going to withhold aid until certain counter-terror benchmarks were met, they might tell us to pound sand.  But it would align their interests more closely with ours, and like all contracts, if the incentives, milestones and payments were generous enough and appropriate to the demands, an agreement would at least be within reach.  And I submit that would be better than paying the Pakistani government billions to essentially pretend to be doing what we ask them to do, all the while making certain the "problem" remains critical enough to require further incentive payments in the future.

The US military is a particularly egregious example.  Inherently, large organizations strive to become larger, increasing their staffing, budgets and scope of responsibility.  It used to be that this tendency was, in the case of the military, effectively checked by the oversight of the political leadership.  The military leadership might have wanted their organization to grow, but they lacked the power to create the necessary conditions.  Wars were declared, managed and ended by the political leadership, leaving the military powerless to effect anything but the outcome of the fighting itself.  But the surest way for a military organization to grow is for there to be 'threats' and wars, and today we leave the management of both entirely up to the judgement of the military leadership themselves.  Our political leaders tell us that wars can only end "when the Generals tell us" they can.  Is it any wonder, really, that we find ourselves embroiled in multiple conflicts around the globe, lasting a decade or more?

Certainly, nobody is going to solve the age-old agency dilemma any time soon.  But it does seem as if it has been allowed to get worse - these kinds of skewed incentives acting as a sort of integral corruption, allowing rent-seekers to capture funds that would otherwise be put to productive use.  And there is no doubt whatsoever that these agreements could be restructured to reward actual solutions instead of becoming the permanent institutions they are now.

But negotiations in the new century have become more about manipulations, leveraging the power of inequality, an imbalance of wealth, of information, of legal power and precedent.  When one thinks about the growing mis-alignment of incentives, it's hard to look past the Patent Office.  Patents used to be a straightforward quid pro quo.  The patent award gave the developer of a new product a period of legally protected exclusivity to make certain he or she was amply rewarded for their invention, at which point the patent would expire so that the price of that product would be driven down by competition.  But years of political intervention, big money lobbying and questionable judicial decisions have turned what should be a straightforward application of governance into a dysfunctional labyrinth of rent seekers and unproductive motivations.  Now patents, and their bastard cousins in copyright law, actually serve to reduce innovation, raising the barriers to new products and new solutions, and the wealth generated by the incumbent rent-seekers is invested back into the political system to raise those barriers even higher.

The point isn't to call attention to a specific problem - the problem is well known, and it's only due to its massive scope that it's at all difficult to see.  The point is about how deeply rooted and intertwined our political and economic problems have become, and how destructive our institutions.  When you look at how the very systems and processes that have been developed to manage incentives and control the agency dilemma have been co-opted and manipulated to produce exactly the kind of counterproductive incentives they were created to prevent, you begin to realize the scale of any meaningful fix.  Root and branch, every nexus of government and industry would have to be torn out, and re-built from the ground up to serve society and community once again.  The fact that these institutions have become so powerful, and so good at protecting their own entrenched interests serves only to guarantee that there can be no fix until the entire system collapses under its own greed.

The end, when it comes, will be harsh, and extremely ugly.  There IS a tipping point.  The top 1% of the American people receive 25% of the income today.  One would think that, in itself, would be unacceptable, but all we can say for certain is that it IS unsustainable.  Eventually the people will realize they have become serfs, and it will occur to them that they are oddly well-armed serfs, and their resentment and envy and greed and fear and bigotry will boil over in a great paroxysm of destruction and bloodletting.  And new governments will arise, with new compacts with their populations, and great fanfare.  And the cycle will begin anew...


  1. it's even worse; the top 1% possess 40% of the wealth in America.

  2. If, for example, we told the Pakistanis that were were going to withhold aid until certain counter-terror benchmarks were met, they might tell us to pound sand.

    Just imagine if we tried to tell the Israelis we were going to withhold aid until they stopped jabbing their fingers in our eyes.