The Political Economy of Indirect Control

77 Pages Posted: 3 May 2012

See all articles by Gerard Padró i Miquel

Gerard Padró i Miquel

London School of Economics & Political Science (LSE); National Bureau of Economic Research (NBER)

Pierre Yared

Columbia Business School - Finance and Economics

Multiple version iconThere are 3 versions of this paper

Date Written: December 2, 2011

Abstract

This paper 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 tradeoff 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.

Keywords: Dynamic Conflict, Institutions, Asymmetric and Private Information, Structure of Government, Dynamic Contracts

JEL Classification: D02, D82, H1

Suggested Citation

Padro i Miquel, Gerard and Yared, Pierre, The Political Economy of Indirect Control (December 2, 2011). Columbia Business School Research Paper No. 12/28. Available at SSRN: https://ssrn.com/abstract=2050110 or http://dx.doi.org/10.2139/ssrn.2050110

Gerard Padro i Miquel

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Pierre Yared (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
Uris Hall
New York, NY 10027
United States

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