Monitor the monitor

In the past few articles, we have analysed the public goods dilemma in some detail. We used Game Theory and analysed the problems and gave real-life policy examples from both domestic and international arenas. We may recall that one of the issues that were crucial in the discussion was the supervision and monitoring of the actors. These are also referred to as principal-agent problems or hierarchy issues (which include the adverse selection and moral hazard issues). Let us discuss these in more detail.

Police Patrols or Fire Alarms

Mathew McCubbins and Thomas Schwartz in an article in 1984 had analysed the lack of oversight by the US Congress on executive decision and implementation of policy. They had divided oversight into two types- Police Patrols and Fire Alarms. Police Patrol oversight was essentially the monitoring or "Patrolling" of the executive or the bureaucracy. It involves summoning of the executive by various legislative committees (at both the central and state levels), a centralised audit of policies and programme review. As opposed to this, Fire Alarm oversight by legislatures involves looking into complaints by several society groups, community groups and other non-governmental actors who provide feedback on various government programmes and policies. Hence, Police Patrol oversight is akin to the use of actual police patrols which is more centralised and direct. Here the US Congress examines various agencies and executives and sees whether there is any violation of legislative goals. On the other hand, Fire Alarm oversight is akin to the use of real-life fire alarms, which are triggered only on the occurrence of a fire. This oversight is clearly less centralised and involves less direct action than Police Patrol oversight. In this, the US Congress relies on individual citizens and community groups to give feedback on how agencies are performing vis-à-vis the various legislative goals.

McCubbins and Schwartz made the argument that the US Congress may not indulge in too much Police Patrol oversight but devotes considerable time and effort to Fire Alarm oversight. This was because Police Patrol oversight involves delegation to the executive where there is a possibility that the executive with more policy experience may have the edge. Further, in Fire Alarm oversight, there is a greater possibility of the Congressmen taking credit by going to the media and publicising their pro-active role.

Insights on supervision and monitoring from the economics of organisation

The issue of supervision and monitoring has been discussed in some detail in the literature of the economics of organisation. In particular, the work of Alchian and Demsetz (1972) is noteworthy. Alchian and Demsetz were taking forward the work of Ronald Coase, who had in his paper 'The Nature of the Firm' in 1937 had theorised that a firm exists to internalise the transaction costs that an economic agent would incur while operating in the market. In other words, the firm with its hierarchical structure is more efficient than the market in carrying out production. Alchian-Demsetz focused on the "shirking- information" problem within the firm. The central concern was to find out how shirking in a firm or free riding can be reduced. In other words, for a firm to be efficient, how can it escape the Prisoners' Dilemma which leads to a sub-optimal outcome. The answer they provided was that shirking or free riding can be mitigated or avoided by monitoring team members. Taking the argument further, they reasoned that since monitoring is costly, the firm can monitor only up to the point where the marginal cost of monitoring outweighs the marginal benefits from reduced shirking. However, there is still another problem, viz., who will monitor the monitor. Alchian and Demsetz argued that the monitor can be a central contracting agent who had an idea about the productivity of all the members. Based on this he would enter into bilateral contracts with each of them. Each member would be paid according to his productivity and the residue would be kept by the monitor. This enhances the incentive to monitor efficiently and maximise productivity and efficiency of the firm. This is essentially the characteristic of a typically neo-classical firm where the monitor is the entrepreneur.

The alternative to the logic provided by Alchian and Demsetz was developed by Williamson in 'Markets and Hierarchy' (1975). Two concepts central to Williamson's ideas were- adverse selection and moral hazard. Adverse selection basically arises from information asymmetry between principal and the agent (for example, employer and employee) and moral hazard on the other hand arises from unobservability of actual behaviour after an applicant has been hired. Shirking behaviour is an aspect of moral hazard.

Finally, the principal-agent model has been used to analyse issues of shirking, free riding, supervision and monitoring. Simply put, one party, the principal, enters into a contractual agreement with the other party, the agent, to work on outcomes as desired by the principal. The principal's main objective is to design an arrangement that will align the objectives of the principal with that of the agent. His difficulty, however, is that there is no sure way to monitor and supervise the agent's action. Here again, the key is to develop efficient monitoring systems and weave them into a contractual framework with the agent.

Essentially, therefore, we return to the two choices that McCubbins and Schwartz had referred to- Police Patrols and Fire Alarms. Which one of these can solve the problems posed by Alchian and Demsetz, Williamson and the principal-agent model discussed above.

Application to Domestic and International Arenas

In the provisioning of public goods we may recall that free-riding must be avoided or else the public goods would be a Prisoners' Dilemma situation where we end up with a sub-optimal outcome.

In the examples of air pollution, water pollution and deforestation that we considered the direct impact of government policies is on the citizens. Hence, it may be more optimal to rely on Fire Alarm oversight which involves greater participation of the citizens, rather than Police Patrol oversight. Take the example of forest conservation measures and the Forest Protection Committee (FPC). Rules are set by the FPC for the use of the forest and members of the FPC are typically assigned duties to monitor whether there is any violation of the rules.

This is a situation which reflects Williamson's argument above and the problems inherent in the principal-agent model discussed above. Moral hazard arises from the fact that office bearers of the Forest Protection Committee cannot observe the behaviour of the members and whether conservation rules are being followed. Similarly, the principal-agent model is reflected in the structure of the relationship between FPC members. The FPC as the principal would like to see the alignment between its objective (forest conservation) and that of individual members who frequent the forest for various purposes. It has been observed that success or failure of FPCs depends, to a large extent, on overcoming the monitoring issues as discussed in the principal-agent model and Williamson's analysis above.

Coming back to McCubbins and Schwartz, in such a scenario, it would be best to use Fire Alarm oversight since Police Patrol would involve more resources and greater reliance on the office-bearers. It is better to depend on the feedback from the community and other non-official structures to see whether forest conservation rules are being violated or not.

In the international arena also, the problems highlighted by the discussion on the economics of organisation can be seen playing out. Again the UNFCC is ceased of moral hazard problems because of the behaviour of various members who refuse to adhere to the multilaterally agreed goals on various parameters such as emissions reduction. Further, if the UNFCC were considered a principal and the various countries as agents, clearly there is no alignment between the principal's objectives of cutting the emissions within a time frame and that of the agents who choose to maximise their individual objectives.

In terms of the McCubbins-Shwartz options, in the climate change example, the UNFCC would be better placed to depend on Fire Alarm oversight. This is basically because Police Patrol oversight would involve engaging with an experienced executive and they would perhaps only highlight their achievements while underplaying the emissions and other targets which have not been achieved. Fire Alarm oversight on the other hand would provide feedback from the ground and experiences of the community which would be valuable in taking forward climate change negotiations.

Conclusion

Better technology has led to more efficient monitoring, which makes Fire Alarm oversight more effective in the detection of violations. It is also a cost-effective alternative since patrolling oversight involves lengthy discussions, which may or may not lead to any firm conclusion.

Dr. Krishna Gupta is the Principal Resident Commissioner, Government of West Bengal. Views expressed are strictly personal