Sunday, July 3, 2016

Agency, Distance, and Subsidiarity

You took advantage of my trust in you
When I was so far away
--The Who

Conditions for agency problems arise whenever people ("principals") contract with other people ("agents") to represent them and in particular to make decisions for them. Celebrities hire agents, owners of companies hire managers, citizens hire government officials, etc.

Because people are axiomatically self-interested, agents are prone to make decisions in their own best interest rather than in the best interest of their principals. For example, agents might pad expense accounts or hire friends rather than the most qualified personnel as subcontractors.

Principals can reduce agency problems by monitoring agent behavior. Obstacles, however, impair effective monitoring. Technically, the specialized skills may be difficult for principles to accurately assess, as in the case of senior managers deciding on which corporate computer operating system to select. Moreover, the 'goodness' of agent behavior may not be immediately evident, as in the case of investment decisions made by a financial advisor. Such impediments, of course, call into question how principals can intelligently select agents to appropriately represent them in the first place.

In many cases, however, monitoring is limited by time--i.e., time that principals have available or are willing to allocate for monitoring agents. Indeed, principles often hire agents so that they free more time for other things. If they spend all their time monitoring agent behavior, then principals have defeated the purpose of hiring agents to begin with. Stated differently, all of their monitoring makes them less free.

The burden of monitoring can be reduced by closing the distance between principal and agent. Locality makes it easier for principals to monitor agent behavior without wasting time. Moreover, the mere prospect that principals are in the neighborhood reduces agency problems. When agents sense that principals are close by and may at any time be watching, then those agents are less prone to mischief.

This was an important reason why the anti-federalists and many of the founders, including Jefferson, weighted decentralization and the principle of subsidiarity so highly. Agency problems, i.e., the costs of freedom, are reduced as distance closes between citizens and government.

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