The Principal Agent Problem

I read something or other last week about “skin in the game”, maybe some Taleb stuff, and it stuck with me…I’m now wondering if the principal-agent problem and skin-in-the-game aren’t two aspects of the same basic problem.

The principal-agent problem:   Principal P hires Agent A to solve some problem.   But…what is good for P is different than what is good for A.  So, P ends up paying A to do what A wants, rather than what P wants.

This is an enormous problem in stock trading (bonus structures), corporate management, representative democracy, and roughly any form of political organization where someone makes decisions nominally in someone else’s best interests.

Skin-in-the-game is theoretically a different problem.  When unelected regulator R makes a rule that impacts Business B and Consumer C, they almost always make bad decisions because the decision they make doesn’t impact them.   They may be trying to make a best decision, but they have no skin in the game, and therefore their level of effort is less than optimal.

And yet a third problem in the category is deciding / paying mismatch.  The fundamental error in the insurance industry (and the education industry) is a mismatch between who decides and who pays.   In insurance in the USA, doctor D decides without paying attention to costs, and Insurance company I pays .   This leads to a bit of a problem on costs.  In Europe, the bureaucrat decides, and the taxpayers pay.  The costs here appear to increase at the same rate as in the US, but from a lower baseline.   In the Kaiser system, the insurance company and the doctors are a single group, so the decide/pay line is somewhat less bad.   In Singapore or in HSAs, the individual decides and pays…which is why it’s the best cost-management system for health costs in the world, along with some of the best outcomes.

In all 3 cases, there are individuals (A, R, D) who are making most of the decisions (in a context) that impact the other players in the scene (P, B, C, I), and whose motivations aren’t aligned.

I think there’s a lot of systems with this structural problem.   Might ought to look at the systems and run analysis.

Who decides?
Nominally, who is this benefiting?
What factors (feedback systems) are in play to make sure that the decision benefit the nominal beneficiaries?

Hume, Hayek & Hanson

When asked to summarize my position on one foot a la Hillel or Rand, I choose neither a phrase nor a saying, but rather 3 alliterative names.   Hume, Hayek, and Hanson.

Hume is the greatest of the philosophers.  All of philosophy can be properly understood as philosophy before Hume and philosophy after Hume.    Before Hume, the question, roughly, was “What is true?”  Since Hume, the question has been “How do you know what is true?”  All of continental philosophy is a response to Kant’s attempt at a response to Hume.   All of Anglo-American philosophy is an acknowledgement that Hume is roughly correct, and how to get around it.

Hayek is the great thinker among the economists.     It took me forever to actually read Hayek, but for 10 years, every other time I encountered a new, impressive position, I noticed that the author credited Hayek for much of the thinking.   Eventually I read the master.    Hayek is best known for the notion that evolutionary systems create information that did not and could not exist without the intermediate interactions.   His most famous line, specifically, is a proof that an omniscient God doing planning could not successfully compete against the market for the goal of satisfying human wants.    The market is better than God could be.   Taking that even ten percent seriously can change what a person believes about everything.

Hanson shows the way to asking better questions.   The joke is:  “Contrarian?  No, meta-contrarian.”  But Hanson is one of the great thinkers of our era.   Not so much because I agree with all his conclusions (I accept most of them).   More because Hanson asks better questions than anyone.    He asks what is true.  He asks how to find out.  He asks how to design systems to find out.  And then he asks why no one cares?  And what do they care about instead?  And how to design systems that make the world better while satisfying decisionmakers.     And he does that about every question I’ve seen him ponder.  Hanson’s brilliance is: “Your question isn’t good enough”.