Academic journal article Economic Inquiry

Credible Commitments and Investment: Does Opportunistic Ability or Incentive Matter?

Academic journal article Economic Inquiry

Credible Commitments and Investment: Does Opportunistic Ability or Incentive Matter?

Article excerpt

The more likely it is that the sovereign will alter property rights for his or her own benefit, the lower the expected returns from investment and the lower in turn the incentive to invest.

--North and Weingast, 1989, p. 803

I. INTRODUCTION

Since at least Hobbes, social scientists have identified "external agents" as necessary for sustaining efficient outcomes in political economies. (1) When such agents are absent, efficient collective order is arguably impossible because individuals cannot by themselves coordinate actions to address common dilemmas. External agents are thought to resolve this impossibility by credibly threatening to inflict punishments where members of a closed system have no incentive to punish themselves.

Social scientists frequently characterize external agents as supplying incentive-aligning services in return for a share of associated efficiency gains. This remuneration scheme, however, provides agents with an incentive to not only create efficiency gains but to opportunistically manipulate the sharing of those gains. Moreover, unless an agent can credibly commit against acting on this incentive, potential subjects to its authority have reduced motivation to enter the game. Hence, although external agents can make efficiency-enhancing actions incentive compatible (i.e., align individual incentives with group objectives), credible commitments against opportunism are necessary for egoistic individuals to subject themselves to an agent's authority.

I evaluate the potential for two types of institutions to facilitate such commitments. The first produces checks on the ability for political agents to act opportunistically. To see how such an institution might work, suppose that a polity formally diffuses authority among, say, an executive and legislature. Given this separation of powers, political agents must act collectively to opportunistically expropriate their constituents' product. If the cost for a (nonsingleton) set of agents to act exceeds that for an individual, then polities that diffuse authority (e.g., establish "veto players") increase the cost for political agents to play opportunistic actions. This increase, in turn, facilitates credible commitments against opportunism and encourages productive economic activity. (2)

The second type of institution shapes the planning horizons of external agents so that even egoistic agents have an incentive to build reputations as nonopportunistic types. For example, political agents who can complete only the term they are serving have relatively little incentive, ceteris paribus, to build or maintain reputations as nonopportunistic types. Besley and Case (1995) formalize this conjecture to argue that "with asymmetric information about politicians' 'types' or some imperfect information about the state of the world, the reelection mechanism can raise effort or otherwise induce less opportunistic behavior" (Besley and Case, 1995, p. 769, emphasis added). (3) Interpreted in this light, formal restrictions on planning horizons (e.g., binding term limits) diminish the capacity for political agents to credibly commit against opportunism and, in turn, the incentive for economic actors to engage in productive activity.

To evaluate the empirical relevance of these hypotheses, I examine the association between investment and institutions that check the ability or incentive for political agents to play opportunistic actions. (4) Egoistic individuals allocate resources to investment if they can recognize a sufficient return. Hence, not only are property rights over an investment's product important, so is the stability of those rights. Stability, in turn, can be stronger when institutions increase the cost of political opportunism. If (i) forgoing benefits from reputation-building and (ii) expending resources to coordinate opportunistic actions are costs of opportunistically altering property rights, then investment should exhibit a positive association with institutions that increase such costs. …

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