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Why Politics is More Fundamental Than Economics

Incentive-Compatible Mechanisms Are Not Credible

Thomas Hammond

Efficient incentive-compatible schemes for resolving hidden action and hidden information problems have been shown to exist, thereby offering the hope that public goods can be provided in a neutral, non-political way. We argue that this hope is illusory. Such schemes inevitably generate a residual profit, and a property right to the residual creates a stake in inefficiency; the residual can be increased by a distortion of the efficient incentive system. In general, therefore, the residual-owners' claims that they will not distort the efficient incentive scheme are not credible. Economic efficiency in the presence of externalities requires the resolution of a fundamentally political problem: the credible commitment of central officials to the implementation of an efficient incentive scheme that is not in their own best interest.

Key Words: economic efficiency • externalities • incentive-compatible schemes • property rights • public goods • residual profit

Journal of Theoretical Politics, Vol. 6, No. 1, 5-26 (1994)
DOI: 10.1177/0951692894006001001


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