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The Political Economy of Indirect Control

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  • Gerard Padró I Miquel
  • Pierre Yared
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    Abstract

    This article characterizes optimal policy when a government uses indirect control to exert its authority. We develop a dynamic principal-agent model in which a principal (a government) delegates the prevention of a disturbance--such as riots, protests, terrorism, crime, or tax evasion--to an agent who has an advantage in accomplishing this task. Our setting is a standard repeated moral hazard model with two additional features. First, the principal is allowed to exert direct control by intervening with an endogenously determined intensity of force which is costly to both players. Second, the principal suffers from limited commitment. Using recursive methods, we derive a fully analytical characterization of the intensity, likelihood, and duration of intervention. The first main insight from our model is that repeated and costly equilibrium interventions are a feature of optimal policy. This is because they are the most efficient credible means for the principal of providing incentives for the agent. The second main insight is a detailed analysis of a fundamental trade-off between the intensity and duration of intervention which is driven by the principal's inability to commit. Finally, we derive sharp predictions regarding the impact of various factors on the optimal intensity, likelihood, and duration of intervention. We discuss these results in the context of some historical episodes. Copyright 2012, Oxford University Press.

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    File URL: http://hdl.handle.net/10.1093/qje/qjs012
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    Bibliographic Info

    Article provided by Oxford University Press in its journal The Quarterly Journal of Economics.

    Volume (Year): 127 (2012)
    Issue (Month): 2 ()
    Pages: 947-1015

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    Handle: RePEc:oup:qjecon:v:127:y:2012:i:2:p:947-1015

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    Cited by:
    1. Wolitzky, Alexander, 2013. "Endogenous institutions and political extremism," Games and Economic Behavior, Elsevier, vol. 81(C), pages 86-100.

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