ONDERZOEKSRAPPORT NR 9318

Managing a Nation: Who is in Charge?

- The Market for Political Control -

D/1993/2376/18

by

Cynthia VAN HULLE

Ajeet N. MATHUR

Contents

CONTENTS

1. Introduction 1

2. The Political World : A First View 2

3. Similarities between the Political Market and Corporate Business 3

4. Characteristics of the Political Market 5

5. Moral Hazards in the Political Market 6

6. Disciplining Forces 8

6.1. The Competition for Votes 9 6.2. The Competition in the Product Market 11

6.3. The Competition among Professionals 12

7. Further research 15

Conclusion 15

References 17

MANAGING A NATION: WHO IS IN CHARGE? The Market for Political Control

1. INTRODUCTION

The process by which political control arises in democracies and the way it is exercised is an enduring source of dissatisfaction, historically endemic and geographically perva­sive. That this be the result of mechanisms designed by the people and for the people raises concerns about the performance of agents entrusted with managing nations. Mechanisms that protect stakeholders against poor performance of managing agents have been extensively studied for the corporate business world and appear to function reasonably well (JENSEN and MECKUNG, 1976; FAMA, 1980; FAMA and JENSEN, 1983, CHEUNG, 1983; and, WILLIAMSON, 1985). The motives and preferences of actors on the political stage have also been scrutinised in a number of studies (STIGLER, 1971 ; BECKER, 1983; SPILLER, 1990; KANDEL and LAZEAR, 1992; MATSUSUKA, 1992). However, important questions in drawing the analogy between the corporate world and the political world have remained unanswered. Does the demand for and supply of institutions and mechanisms of political control follow market logic ? Are the incentive structures and disciplining devices effective? What precisely are the constellation of forces that shape the decisions of players in the market for political control ? Do political systems provide safeguards that "public interest" is accurately and comprehensively defined, articulated and transferred into actionable forms ? These are the questions that this paper examines in an attempt to illustrate the potential and limitations of comparing the market for political control with the corporate business world.

By taking a holographic perspective we come to the conclusion that, in a rational world, contrary to the market for corporate control in which market forces limit inefficiencies, important inefficiencies are likely to persist in the political world. The reason is three­fold. First, since politicians and parties cannot make binding commitments beyond their term in office in a democracy, politicians tend to favour short term results. Second, for reasons explained in the paper, the market for political control is likely to be less competitive than the market for corporate control. Thirdly, the absence of a well defined and unanimously accepted goal (in the business world this is maximisation of firm value), in conjunction with the limited competition, leaves much room for wasteful influencing activity. It follows that the political system is likely to benefit professionals that are good at building influencing capital.

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2. THE POLITICAL WORLD : A FIRST VIEW

The diversity in the range of political philosophies, systems of government, institutions and practices which are specific to nations need not be a limiting factor for our analysis if we conceptualise the issues involved that form a common recurrent theme in the politics of all countries. We may regard any nation-state as an association of persons where the basis for territorial association claims supremacy over all other associations within its boundaries, where membership is compulsory; and where the entity possesses independent power to force compliance from the population within its territory through a monopoly of the use of force and agents acting in the name of the land and its people. The government, may then be viewed as an institutionalised concept actionable through people's representation to engage in a variety of functions such as internal and external security, conduct of foreign relations, supervision of conflict resolution including adjudi­cation, regulatory establishment and active enforcement of standards, law enforcement and corrective activities through the use of sanctions, inducements and penalties, and entrepreneurial activities all of these expressly authorised, usually through constitu­tional objectives that bind the people as a nation.

While the array of functions mentioned do not change, their relative importance and the way the national goals and tasks are mandated leads to a variety of potential activity bundles which require public preferences to be matched with resource allocation to alternative tasks and goals as well as rationing. For reasons listed by STIGLER (1971), decisions involving public resources and majority preferencing would be prohibitively expensive if direct expressions of preferences were to be exercised; therefore represen­tation is a rational response. This brings us to the role of interest groups, pressure groups, political parties and individuals as politicians, each of whom influence the process of market-making.

We may regard any group of persons who share one or more concerns or wants or claims upon society in general or upon other groups in society as an interest group seeking to maintain or promote its position or objectives. An interest group that attempts to influence society becomes a pressure group and may choose to influence government or political parties or both. A pressure group, by itself, or in combination with other pressure groups may organize to acquire and exercise political power, as in the case of the Labour Party in Britain. Political parties also arise when groups of persons combine and choose to specialise as players in the political market by establish­ing organisations to acquire and exercise political power. In either case, a political party requires to seek out issues and interest groups other than itself (a political party by defi­nition is both an interest group and a pressure group) and to develop or shun contacts with the various pressure groups.

Although the objectives of a nation and its government are institutionally defined, the response on issues that comprise hopes, demands, claims and disputes enables goal-setting and task construction in many different ways. Thus, the first level differentiation between individual politicians as well as between parties is based on goals and activity bundles, competing to be the closest most promising public preference to the largest number.

3. SIMILARITIES BETWEEN THE POLITICAL MARKET AND CORPORATE BUSINESS

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Political activity involves features of organisation such that a nexus of contracts between individuals is preferred to a system of independently operating politicians, for reasons of scale and effective organisation through structuring and norm setting. From the perspective of Coaseian Economics (COASE, 1937), multi-individual business firms are formed for the same reasons.

The size and number of firms (i.e. parties) in the political market, like business firms in any industry, is influenced by the size of the market and its segmentation (into different interest groups and pressure groups) and applicable regulations such as ones with respect to financing, minimum threshold size required to obtain a seat in Parlia­ment, the number of individuals that can be seated in Parliament etc.

The population as stakeholders in the nation are required to choose between competing individuals and political parties. Political parties resemble firms bidding for a share of control in Nation Inc. through acquisition of agency rights. If we consider the whole government system as one large corporation in which all voters are assigned one vote, this corporation's Board of Directors (i.e. Parliament) are elected through a periodic vote. Agency shares in terms of Board seats are determined on the basis of popular vote (by following pluralism or majority vote), and executive powers of Government are entrusted to the party or coalition that enjoys the support of a majority in parliament as managing agents.

When political parties are viewed as firms specialising in country management, this system is strikingly similar to the way corporate control is exercised in large business firms with publicly quoted shares. In corporate business, firms or holding trusts typically hold large blocks of shares in other firms for the purpose of acquiring and exercising control. There are many examples of this in Continental Europe, Japan, India and the U.S.A.. This is done through "shareholder syndicate contracts" involving standstill agreements and pre-arrangements on voting behaviour that facilitate coalition formation, usually distributing directors' seats in proportion to the number of votes held, and appointing "top management". Voting for Parliament can also be interpreted as an institutionalised form of assembling large blocks of votes by specialised firms (i.e. parties). These firms may also form a majority coalition through syndicate contracts and assign government seats establishing a hierarchy of control.

This setting may now be compared in the organisation of activity, incentive structure and disciplining devices with the corporate business sector. From the agency perspective, the business firm and the political party as a firm are both characterised by a set of contracts: objectives are defined, tasks are designed, an organisation network is created to support the task system and activities involve entering into more contracts. Within the framework of contracts, inputs are converted into outcomes through a process of transformation called management. Just as the value addition associated with the process of transformation relates to conversion of raw materials into finished goods and services in the business sector, a political party offers to convert problems and issues into solutions by developing policies and programmes that have a market. Many

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advantages provided by organising business activity through multi-agent firms apply also in the political world. Just as in business, the party mechanism provides the career politician with a vehicle of continuity.

When a party announces a set of preferences it makes a decision about the type of "products" it intends to produce and invites contracts on the basis of tangible invest­ments. Just as business firms require sufficient agreement over goals and resources through the instrumentality of budgets, targets and coordinated action, a limited number of multi-agent parties become the locus of assembly for harmonising activities where the number of products is more than what an individual could credibly promise. In addition, the streamlining of products provides for synergy and stronger profiles. Also, reputational capital built across generations of political or business professionals is safeguarded institutionally. Party or business firm information creates barriers to entry in the industry (LOTI, 1986; LOTI, 1987; and COATS & DALTON, 1992) because the build­up of non-tradable reputational capital investment is an important product of the demo­cratic and market process. The party or business firm as a disciplining device has also been cited as mitigating agency problems, even in respect of those who know it is their last period in the political or business labour market (ALESINA and SPEAR, 1988). Also the choice of products of business and political firms shows similarities. As in the business world, a party is rewarded for the discovery as well as the invention of consumer desires. Changes in product characterisitics are a known marketing phenomenon in the business world; similarly, private definitions of the public interest may also change with time with the proviso that members of a party like a corporate firm would always need to support and justify the characteristics at any given time. In this the top level politician emerges as someone holding temporarily a franchise, whereby the location and action radius of the franchise is determined by the country's subdivision in the largest voting districts. Simultaneously this politician is also a vendor, as he/ she supplies services to "head office". Lower level politicians appear as individuals holding subfranchises with a smaller regional action radius. Members of the party not seeking election are pure vendors. In the remainder of the article we do not consider these latter individuals anymore and hence by a "politician" we mean a profes­sional seeking election. The franchise is temporary in the sense that, just as for any other professional, the firm (i.e. party) may decide to "fire" the politician and give someone else the party's support next election time.

Both in the market for political and corporate control the mobilisation of blocks of votes is used as a device to overcome the "free rider" dilemma of small stake holder­ship (i.e. why would small stake holder 1 expend monitoring effort as stakeholders 2, 3, ... have as much interest in monitoring and could do this as well ?). "Syndicate contracts" in business need not be limited by time, except by regulation in certain instances, whereas political contracts with voters and alliances resembling "syndicate contracts" are limited by election spans. Just as in the corporate sector, blockholders left out of "syndicate contracts" may receive directors' seats, in the political world they may have to be content with seats in Parliament. Just as the Board of Directors performs supervisory functions on the management of a business firm, Parliament supervises the management of Nation Inc.

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4. CHARACTERISTICS OF THE POLITICAL MARKET

Although the declared intent of any democracy's political system is people's participa­tion, the market is typically, a sellers' market. This is because, unlike the business world that presents possibilities for consumers to turn to producers outside the national market, here the market is limited by the notion of national sovereignity that binds consumers down to the national market. So, unless consumers are willing to become suppliers or influence suppliers, consumer choice is limited to the existing players in a national market. Furthermore, even within this national market, the party industry is likely to show imperfect competition, and this for reasons elaborated in section 6.

Another factor that differentiates the functioning of the political world as compared to business, is the relative inalienability of political capital. This inalienability is clearly visible for an individual voter, as votes cannot be traded. Maybe less visible but nonetheless as real is the relative "untradability" of political capital of a professional politician. Changing parties means changing the franchise, which is unlikely to be as easy as changing jobs in the business world. Furthermore, from the point of view of the party accepting the new member among its ranks, such an acceptance may involve a reorganisation when this party already has a franchise operating in the new member's region. Also on the level of parties, "brand names" cannot be sold (COATS and DALTON, 1992), although in business it is a common phenomenon. In all these cases political capital is inalienable because the market solution through trading is unaccept­able democratically.

For the same reason, in a democracy, in principle, influence in government is a perishable good limited to terms of office. In contrast, in the business world continuity is defended as being in the best interests of the firm. In Nation Inc. voters desire transparancy as do competing firms in the political industry. In practice party capital does not perish at the end of the term of office, because there is always the possibility of reelection. Of course, since a large fraction of party capital consists of influencing capacity, its value is likely to vary with the number of seats in parlaiment and with the party's participation in delivering managing agents.

Another element that distinguishes the political world from the business world is the type of product it sells. Many political products are mutually exclusive. Also contrary to a typical private business product, consumers are forced to consume what politicians in government produce. At election time a certain product is promised; once a party is in government it should deliver. Let us first consider the choice of product promised. In a world in which voters would be well informed, the costs of changing products would be minimal: because of transparancy in a democracy there is no "inside" management information either about the product itself nor about the market for it. However when voters are not well informed, continuity in product choice decreases voters' information costs. This is similar to the problem of sticky prices to mitigate information costs (SPENCE, 1974; SPIER, 1992; EICHNER, 1976). Continuity also decreases information costs on pressure groups that invest in establishing influencing networks with certain parties, and that may develop activities supporting these parties (e.g. chanel processed information to the voters belonging to the pressure group, ... ). Hence this continuity creates a valuable reputation and barrier to entry. Also for the party itself,

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continuity minimises information costs concerning the size of their product's market and also the risks of choosing the "wrong" product at election time (i.e. a product with a market smaller than expected, especially as a party is a non diversified firm). Conse­quently continuity in product choice also enhances continuity in government: the same parties get seats in parliament election after election; these same parties also regularly supply the managing agents in government. In fact continuity in the choice of product has many advantages similar to those of creating a multi-agent firm. Continuity in product choice does not imply that no adjustments are made over time. As discussed before, such adjustments occur as the market (i.e. voters' concerns) changes over time. After elections, delivery should start. However, in comparison with the business world there is much ambiguity about the product that actually gets delivered. In business, failure to deliver according to contract specifications entails penalties of damages and legal punishment ; not so in politics. In fact the degree to which the political product promised actually corresponds to the one delivered is often hard to assess. In fact all a party promises is that, conditional on receiving director seats, it will influence the deci­sions of government in accordance with the bundle of promises made at election time. Hence evaluation and ex-post settling up also becomes a more ambiguous process.

Ambiguity is further enhanced by the fact that, contrary to the business world, claims assignments are neither prespecified nor structured. In the business world such assignment is very much institutionalised and limited by the corporate charter and business law. Not so in government. This freedom in choice produces ambiguity because there is not a well specified and unanimously supported goal like the value maximisation criterion in the business world. In view of the large potential impact of government decisions and the enormous leeway in governmental decision making it is not surprising that much resources are spend on attempts at influencing and that this influencing activity itself, in many countries, has developed into a well organised industry.

Both the correspondences and differences between the business and political world, discussed in the previous and present section, have their implications for the type of moral hazard problems that may arise in politics. This is the subject we now turn to.

5. MORAL HAZARDS IN THE POLITICAL MARKET

While blocks of votes may be permanently assembled in the business sector, the political system does not enable its vote assemblers to negotiate their shares in control for the next time period. Therefore, contrary to large block holders of shares in business, who stay in control easier if small shareholders do not vote, competition among the proposals of political parties pushes these parties into getting people to vote. (1) When

1 This is in contrast with the business world. Non voting by shareholders results in plans, proposed by the incumbents, being accepted. Only when several management teams compete for control (e.g. at the time of a take over or a proxy fight) then one also observes efforts by control contestants to get votes. About the preselection of corporate management at the general assembly, see below, this section.

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we assume away the free rider problem by postulating that the pressure for voting arises from the efforts by parties to mobilise votes (since this is not without cost, the obligation to vote need not be mandated by law if we can consider the cost of voting to be borne by or through the parties in one way or another and which may also involve selective incentives), several problems remain. Voters guided by self-interest may not vote for the party with the highest quality public interest plan as they are rationally attracted by firms that best serve the interest group to which these voters belong. Even more, voters may decide in favour of that politician that is good at personal servicing (e.g. speeding up an administrative processing, support on personal grievances with respect to the government machinery, be present at social activities, etc.). The outcome of personal servicing can be viewed with considerable precision, and if voters value the personal servicing aspect highly, their assessment of the performance of a party is likely to be based on narrower considerations than even that of special interests groups. In such a case, we would expect a party to look for new avenues of service that complement its existing products and there may even be a trade-off between its public purpose products and servicing products to strengthen its competitive position. Our argument is consis­tent with Becker's conclusion that political influence is not fixed by the political process and can be expanded by investments (BECKER, 1983). The maximum investment in the political market along these lines would be limited only by the productivity of such investment for firms who would desire to optimise their investments in relation to the behaviour of other firms. Since parties compete for votes, this has features of a dollar auction game. The dollar auction game invites bids for $ 1 with the proviso that the second highest bidder forfeits his investments. Therefore, once more then one bid arises, unless there are uniformly applicable resource constraints acknowledged and recognised by the bidders, firms must go on bidding. In either case, the incentive for seeking a return on investment for votes so accumulated must find expression in the behaviour of managing agents and directors, who would collectively need to condone "norms" that arise to finance such investment, while in office and outside it. The within party pressure to live up to these norms is likely to be strong; as it may not be so easy for an individual politician to change parties (see sections 4 and 6), this individual can not afford to flagrantly go against these norms. Furthermore imperfect competition in the · market for political control (through barriers of entry, see sections 4 and 6) further enhances the development of norms putting lids on party investments and hence stopping the dollar auction game.

The second problem arises from the time span of control since managing agents have no power to make commitments beyond their term of office. Hence an important consideration in decision making is short term visible impact whereby benefiting supporting special interest groups is an important issue. This follows from the reliance on special interest groups to keep office. In the business world the incentive to go for short term results is much more limited. As pointed out in Fama (1980), if competition among firms for survival is strong enough and professional managers compete in a sufficiently well informed labour market with optimal incentive contracts (NARAYANAN (1985, 1987), and DARROUGH (1987), managers serve the long term goal of the firm (i.e. maximise firm value; see section 6). Similar information and competition in the political market would not solve the short sightedness problem in the political world because of the lack of a unanimously supported long term goal and the impossibility to make long term commitments.

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Thirdly, the political process does not limit participation in proportion to interest and knowledge nor does it offer incentives to acquire knowledge about alternative consumption baskets. In the business world this problem is alleviated by the tractability of shares. The possibility of making profits on trading in the stock market by assembling information has created an industry of information collection and analysis. Large share holders have incentives to actively evaluate the proposals of the managing agents and compare them to alternatives (see section 6 for further elaboration).

Fourthly, it is cheaper to lobby with special interest groups than influence millions of voters. In addition pressure groups provide parties with information about how certain proposals are received by those belonging to the group, so parties may also save on information gathering costs. Of course ultimately such lobbying with special interest groups is productive if votes can be gained. Studies report that decision making is characterised by herd behaviour because decision makers assume previous decision makers to be rational and holding some information that may be important (BANERJEE, 1992). Hence this supports the view that special interest groups are likely to have an impact on voting behaviour. This rational ignorance is also attributed to voters in the Downsian model (DoWNS, 1957) and the political business cycle literature (NORDHAUS, 1975; FIORINA, 1981). However PELTZMAN (1990) finds that the voting market is a surprisingly good aggregator of information for settling up the agent's performance. This is not contrary to the hypothesis that special interests do influence voting behaviour; all that is needed for consistency with Peltzman's findings is some correla­tion of the well being of special interests groups with national circumstances (we would expect this for example on issues like inflation, unemployment etc., which are exactly the issues tested by Peltzman). When special interest groups are an important factor in voting, parties would need to pick candidates that supporting special interest groups prefer relative to others. Hence voters' choice is limited to distinguishing among a set of active agents in a competitive career system. This selection of candidates is likely to enhance the tendency towards decision making for the short run. In business, at the general assembly, shareholders usually have even a more limited set to choose top management and directors from. In this case preselection has been realised by the management labour market. However it is well known (see section 6) that, if this market is competitive, this preselection results in the best managers taking control.

The question that now arises is, to what extent can competitive forces limit moral hazard in the political market; what are the monitoring mechanisms and disciplining devices and how well do they function as compared to the business world ? We tum to this next.

6. DISCIPLINING FORCES

In the business world, the forces disciplining management have been well studied. It is generally agreed that under sufficiently competitive circumstances all managers are perfectly disciplined and maximise firm value. Thereby the system selects the ''best" managers, i.e. promotes those managers that create most value. The main disciplining forces studied are: the possibility of voting and the competition for votes, the competi­tion among professional managers in the management labour market (whereby these

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managers may be operating under optimal incentive contracts) and the competition in the product markets.The work of Fama indicates that among the disciplining forces, the competition among managers is likely to be the strongest one. We should ask to what extent preceding competitive forces are likely to lead to an efficient functioning of Nation Inc.; what is likely to -be the main monitoring force and are the "best" politicians likely to . be rewarded for the quality of their work? We now turn to a comparison of the disciplining forces in business and politics.

6.1. The Competition for Votes

As discussed in FAMA (1980), voting may not be a strong disciplining device in private firms, if ownership of the shares is distributed over many small investors. Due to the free rider problem small owners may not keep track of the performance of corporate management and of possible alternative corporate strategies. Nevertheless several market forces alleviate this problem. As mentionned before, the possibility of making profits in the stock market by the timely acquisition of high quality information creates incentives to monitor and evaluate firm performance. Motivated by the pay offs an investor in securities can derive from correct and well processed information, profes­sional information processing firms (e.g. rating agencies) can thrive on the fees paid for their products. The economic value of these firms is clearly purely reputational and hence they have a full interest in providing "independent and neutral" information. Free riding can be also be overcome through the process of a take over or a proxy fight: professionals interested in corporate control can always buy shares and/ or acquire proxies, gain control and adjust top management. However, the take over disciplining and, as pointed out by Pound (1988), especially the proxy contest may be a costly device. The rules of the game benefit the incumbent in the business world who may set the record date (i.e. the date on which ownership is counted to determine who may vote). Large shareholders frequently enjoy privileges and beneficial contracts from incumbent managing agents, and voting is subject to disclosure that together create problems akin to that of special interest groups in politics. That is, deviation from value maximisation may occur in case a large controlling shareholder expropriates small owners through transformation of security benefits (dividends) into benefits of control. In that case unanimity about the goal of the firm is broken, and conflict of interests arise. However, because in the business world long term commitment contracts are possible (until the time the large shareholder decides to sell his/her shares, he/she stays in control), there is no reason to believe that these conflicting interests should lead to pressure for short term results. Furthermore, with legally enforced limits on expropriation by large share­holders (in most countries small and minority shareholders are legally protected), conflicts of interests are bounded as are possible deviations from efficiency. Further­more the alternative claimant is also hardpressed to prove that the take over would be beneficial because of reputational effects. The cost of entry is itself a barrier in business take over bids and would require to be recovered either by real improvements or the transfer of wealth through control benefits. Nevertheless Fama and Jensen (1983) point out that insider take over bids by dissidents are possible even when external take over bids are constrained by market structure. Overall however it appears that the market for votes on its own is not capable of perfectly solving all moral hazard problems in business.

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A comparison of the preceding discussion with the discussion of moral hazard problems in politics, immediately indicates that the situation is likely to be worse there. The free rider problem also leads voters to be imperfectly informed about the true efficiency of a party, especially for non special interest issues. Even more problemati­cally, even if voters would know that a party or politician is more efficient at macro issues, they may still vote for a less efficient party if their special interests are served better by the latter. Hence, only on the level of special interests, efficiency becomes an important force. Obviously if efficiency aberrations with respect to macro issues become so important and the consequences so well observable and disastrous that the latter outweigh the gains from supporting special interests, only then macro issues may prevail. Also the forces alleviating the free rider problem appear less powerful. Although political news can be of interest to individuals (e.g. by understanding the consequences of political decisions, individuals can optimise their personal tax management etc.), continuous in depth information is likely to be less valuable to the individual "small shareholder" in politics as compared to the business world. Hence the political press has less reputational capital to defend. In fact, in practice, many news­papers have definite "preferences" and in their comments usually side with a specific party. This all but eliminates the media from playing a part in market controls on managing agents. The incentive for mud-slinging requires special mention because agents can try to benefit from misrepresenting the performance of competing agents as well as their own performance. Within a party, this problem arises because individuals wish to acquire a better position in the party's ranks. Between parties, mud slinging may aim to discredit the competing firm. It is clearly a more prominent feature of the political world as compared to the business world. In practice, mud slinging between business firms is legally outlawed as dishonest competition. This is not so in politics because politics is manifestly concerned with public interest. However, this double­edged weapon's effect is likely to cancel itself out since the media is accessible to all. Furthermore as votes are non tradable, only contests resembling proxy fights are possi­ble. Here too problems similar to those of the business world arise. For example, also in the political world there are instances of electoral rolls being frozen at particular dates, of managing agents calling mid-term polls at times they determine to be the most convenient etc. New parties suffer from reputational effects (see section 4) and the absence of well established links with supporting pressure groups creates barriers to entry.

Nevertheless the main problem with voting in politics, one that persists even under ideal information conditions, is the incentive to go for special interests. And the answer to the question for what or whom voters vote (i.e. for a party or for an individual politician) is not likely to make much of a difference. This observation incorporates the answer to the question: what does "efficiency" mean in this political context? Special interests favour a politician who discovers wants of supporting special interest groups and who can influence government decisions towards favouring these wants. So an efficient politician is someone with much influencing capacity, especially w.r.t. special interests.

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6. 2. The Competition in the Product Market

In private business, competition in product markets is known to be a strong resolver of principal agent slack. To survive, companies need a value maximising management. How competitive is the market for political products likely to be in comparison with business products ?

In the business world there often are many producers of the same product or of close substitute products. Thereby consumers are not confined to buy products only from local (i.e. national) producers. In general, in private business there is room for many different goods. Continuously new products emerge, giving rise to opportunities for new activities, and other goods and services become obsolete. It seems unlikely that as many different political products can viably coexist. In fact one can ask the question how large the potential market for a particular product must be in the political world to be viable. Looking at the world as it actually exists, we observe only a limited number of different products being (successfully) offered, as compared to the number of business products (2). Furthermore there does not seem to be a problem with fast obsolence as is the case in certain industries. So, if the most successful products are already being produced by some party, there is not really room for another party to start up with an alternative and successful product. Furthermore reputation effects and established links with supporting pressure groups may create barriers to entry for alter­native producers of political products. Also, in many countries, the law requires politi­cal parties to obtain a minimal percentage of all votes (e.g. 5%, 10%) for the party to be assigned seats in parliament. This minimal size requirement also forms a barrier to entry if campaigning is costly. However, with costly campaigning this minimal size requirement has the advantage that it is likely to deter non-serious parties from being formed. The same logic enhances the credibility of new parties that actually set up. Furthermore the fact that customers cannot tum to producers outside the national market insulates parties from international competition. Finally increasing returns to scale may drive potential alternative producers to team up as evidenced by the consoli­dation of competing parties into fewer numbers in mature democracies. Hence it is not surprising that in practice, in contrast to the business world, we do not observe several political parties in one country producing the same product. One factor that potentially enhances competition is the fact that political parties operate in a basically stagnant product market : the number of seats in parliament is normally fixed ; this gives compe­tition aspects of a zero-sum game at election time whereby parties participate in the dollar auction disc11ssed in section 5. However this is only a myopic perspective. The continuity in product choice and the barriers to entry create a situation where time after time the same parties enter into competition and into the "syndicate" contract to form government. Hence, well established parties are involved in an infinitely repeated prisoners dilemma. So there is room for "norms" of behaviour that avoid cutthroat competition, even at election time. For example, in several countries (e.g. Belgium, .... ) parties have agreed to endorse a law limiting campaign spending. In the business world, agreements among the firms of an industry to avoid publicity or price wars,

2 The universe of political philosophies is itself finite with common strands when we consider the whole spectrum comprising Anarchism, Christian Socialism, Communism, Conservatism, Constitutional Monarchy, Fascism, Fourierism, Guild Socialism, Jingoism, Leninism, Uberalism, Maoism, Marxism, Radicalism, Republican Democracy, Social Democracy, Stalinism, Totalitarianism, Trotskyism and Utopia.

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would be considered undesirable cartels. The rationale to allow it in politics is that otherwise parties would accumulate too many lOU's (i.e. it is an attempt to limit the influence of special interests on government policy).

Another factor that is likely to limit the disciplining force of the political product market is the type of product produced and the way delivery is organised. In principle, even if politicians as a group deliver unsatisfactory quality products, the "purchases" of political goods cannot drop to zero as consumers of Nation Inc. are forced to consume these goods. Furthermore it is generally difficult to assess the extent to which the political product promised corresponds to the product actually delivered (see section 4). And even if consumers discover a discrepancy with the promises, they cannot take the party to court instantly. The moment of reckoning is postponed to election time, and hence contrary to a business firm which is continously under direct performance pressure, at least for a while a party is insulated from the consequences of mishaps. In fact, when all parties would make mishaps, in view of the barriers to entry and the fact that consumers have to consume political products, it is not so clear what the consequences would be as compared to the impact of mistakes in the business world. Italy, ridden with mafia­corruption scandals in the early 90s is an example of a Nation Inc. in which a majority of parties have made mistakes. One could say that the mafia, having infiltrated the most important parties, has become a collusive force in the political industry, and also, given the links with existing parties, has interest in helping to create barriers to entry. In fact the case of Italy is an example of how the influencing industry may become a collusive factor and enhance barriers to entry.

6. 3. Competition among Professionals

FAMA (1980) gives a detailed analysis of how, in corporate business, through ex post settling up, the principal-agent problem is resolved. Each manager, concerned with his/her reputation and hence value in the management labour market, tries to show a strong performance in adding value. Furthermore, if his/her marginal product is a positive function of the performance of all the other managers in the firm, he/ she has also an incentive to monitor fellow managers. For although higher managers are affected more than lower managers, all managers realise that the managerial labour market uses the performance of the firm to determine each manager's outside opportu­nity wage. Obviously such mutual monitoring activity may require that among profes­sional managers obtaining information about other managers, sufficient for full ex post settling up, is cheap enough so that the incentives to monitor each other outweigh the benefits of free riding (why expend resources on monitoring your colleague number 1 if your colleague number 2 has also an interest in monitoring this same colleague number 1 ?). Managers that would not get their right pay can protect themselves against such pay dilution by simply moving to another firm. Furthermore, in case of separation of ownership and management, the threat of take over constitutes some additional (although costly) disciplining force for managers to maximise firm value. Nevertheless this competition may still fail to give the right incentives. For one thing, managers may work too hard when young and not enough when old because, when young they try to build a reputation of quality. Furthermore, because of reputational concerns they may have a preference for projects that give pay offs quickly, even if these projects do not

13.

maximise value (NARAYANAN (1985)). However all these problems can be solved by supplementing the forces of the competitive labour market with the right payment contracts (see NARAYANAN (1987) and DARROUGH (1987)). In fact, the shortsightedness problem disappears as soon as other managers can distinguish between projects that have less but immediate pay offs and those where pay offs are better but only come later. In such case the management labour market is not fooled, and there is no incentive for short term results. Finally if product markets are perfectly competitive, the survival of the firm depends on the consolidated talent and effort of all managers in the firm. Hence again a strong incentive to monitor each other. So as Fama (1980) concludes, the strongest montoring force in business is not the vote of the uninformed small shareholder but the monitoring by well informed professional managers. Of course in reality information conditions are not perfect, so the monitoring is not perfect either. But this is not our concern. The question we are interested in is whether under "ideal" information conditions, as in the business world, moral hazard problems would disappear in politics. We will see the answer is : not likely.

The party system, like a private business firm, shifts disciplining and monitoring away from the small stake holders to professionals. So, potentially, also in politics, the competition among professionals is likely to be the main disciplining force, especially as the competition for votes and the competition in the product market are far from perfect as disciplining mechanisms. However, the disciplining capacity of the professional labour market is also likely to be weaker as compared to the business world. First of all, because of the ambiguity of the political product, it may not be so easy to evaluate the performance of a professional politician. Furthermore, due to imperfect competition in the product market, politicians of the same party can grant each other some slack. In addition, this imperfect competition and especially the limited number of successful parties in itself reduces the disciplining of party organisations by the political labour market. Due to the limited availability of alternative party organisations a politician can join, combined with costs of moving (see section 4), party organisations operate under some insulation from the competition for political management talent in the political labour market. Hence, once a politician is in a party, moving to a competing party is difficult so that the politician is committed. Consequently career competition within a party may result in unproductive (from an efficiency point of view) influencing activity

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as described in MILGROM (1988). (3) Of course to limit to some extent this influencing activity, a party may, like private business firms, develop a set of formal rules through which advantages are assigned. However, such a set of rules is not likely to solve all problems. In private business these are further supplemented by the pressure toward efficiency and reputational concerns: a "good" manager observing too much unproduc­tive influencing activity in one firm has an incentive to quit and move towards another one. On its own, this protection from a competitive management labour market suffices to drive the level of influencing activity down to a low level. In contrast, to rise through the ranks of the organisation (i.e. be chosen to receive the party's support at election), a politician has to possess influencing capacity. Binding precommitment contracts at the time a politician joins a party, is not likely to solve the influencing problem as such contracts can be regarded as part of the formal rules of the party organisation. One could argue that the low career mobility enhances the incentives of politicians within a party to monitor each other. This may be true from top to bottom, whereby the top strongly imposes party norms on those below. However there is not likely to be that much monitoring among equals and certainly not from bottom to top (as is also the case in private business firms, at least under the competitive conditions discussed above). As the individual politicians is less protected by a competitive labour market, his/her further career depends upon the support of his/her equals and superiors. Hence a strong incentive to free ride upon the monitoring efforts of others. Finally, in the absence of some widely used business world tools like, for example, stock options, it also seems harder to design optimal incentive contracts in the political world.

In principle, in the classicial view on the political system, the role of disciplining is assigned to parlaiment, and especially the opposition. Taking into account the preceding arguments the discussion can be short. To the uninformed small stake holder, the voicing of disagreement with the managing agents in government by the opposition, is hardly distinguishable from mud slinging, for it is in the oppositions' best interest to make parties in government look bad. Hence one would not expect that voting·would reward the opposition for good monitoring. Furthermore, since the opposition itself consists of parties it is not free from the problems discussed in relation to the party with managing agency status. Hence, one would not expect the opposition to be a very powerful disciplining device.

3 Influencing activity absorbs time and effort and is essentially non-productive at the level of the organisation as a whole. It consists of the efforts spent by individuals to shift advantages from other individuals in the organisation towards themselves.

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7. FURTHER RESEARCH

A venues for further research are many, as are links with different areas of research. For example, the behaviour of smaller as compared to larger parties could be studied with the methods of industrial organisation. Party restructuring in the absence of tradability of shares could be looked at more in detail. Also the impact of the influencing industry on the competitiveness of the political system could be an interesting subject. Also the choice between a coalition system and a system where only one party delivers managing agents and its impact on competitive behaviour could be a topic for further research, as well as the optimal time lag between elections. A link with research in psychology could be the empirical investigation of the hypothesis that political managers have aptitudes, talents and orientation different from those of managers in the business world. For instance, compiling profile inventories of politicians using instru­ments like Kostick Papi to test for differences with managerial talent in the corporate business world, would be revealing.

Links with strands of literature presuming logical irrationality (e.g. are prefer­ences part of the utility function ?) and the covert dynamics of large groups and inter­group behaviour can also be pursued to combine rational expectations with the insights from work into the unconscious process using the open system model.

CONCLUSION

We find that the institutions and mechanisms of political control emerge from the market logic of demand and supply. Atomistic voters require to be consolidated to overcome free riding. Such consolidation requires organisation through assembling special interest groups. Individual agents find it convenient to form parties to develop generic products as particular consolidations acquire size to reap the benefits of scale and reputation. The range of products being limited and the presence of entry barriers limits the number of such enterprises. Canvassing for votes resembles a dollar auction game and influence in government a perishable good, and the development of norms to avoid cutthroat competition is a response to an infinitely repeated prisoner's dilemma.

Special interest group concerns assume greater importance than "public purpose" goals and are trouble free to pursue in the absence of unanimity about measures of performance (such as maximisation of shareholder's wealth for a corporate business firm). The attractiveness of personal servicing in contrast to "national good" for the voter together with shortsightedness (a rational response when contracts are timebound) is engendered by trying to harmonise delivery schedules that involve short term benefits for special interest groups and payoffs in reputational capital or tangible returns on investments made by politicians.

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While there is a high degree of correspondence between the characterisitcs of the corporate business world and the political market (both have to overcome the free rider problem), the problems of monitoring remain unresolved in the political world, even under ideal conditions. The system cannot provide adequate safegards and full ex-post settling up since there can be no long term commitments. This is accentuated by the presence of constraints on competition, the ambiguity and dilution of objective setting and performance measurement and the inalienability of political capital. The premium placed on the servicing of special interest groups in a limited product market sustains market inefficiencies in the absence of effective disciplining forces. High value is thereby assigned to influencing capacity.

Hence the classical agency problem is magnified in the political market by rigidi­ties in the shape of institutions and mechanisms that screen out the feasibility of effective matching of preferences for "national good" with the action of agents entrusted with management of Nation Inc.

References I 17.

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