Once again, Minnesota’s governor and Legislature seem deadlocked on budget issues. This is a perennial problem, but the stakes are particularly high as the state faces a very large budget shortfall. Moreover, this is against a backdrop of the worst recession and highest unemployment in 26 years.
Much evidence indicates that a majority of the state’s citizens want a pragmatic, centrist compromise on budget issues and would like the budget to be in at least rough balance over the long term. Most are willing to sacrifice some dearly held spending program, and most are willing to pay somewhat higher taxes.
Unfortunately, it seems many elected officials play toward the ends of the spectrum, rather than the center. They must have good reasons to do so, especially in terms of anticipated electoral success. We need to find a way of changing incentives so that there is greater willingness to compromise earlier in the process.
That is why it is too bad Leo Hurwicz no longer is around to help. The old sage, who taught at the University of Minnesota for 57 years, won the 2007 Nobel Prize in Economics, along with two other researchers, “for having laid the foundations of mechanism design theory.” He died a half-year later.
Mechanism design involves structuring a policy or institution so that economic agents work to achieve an outcome that is good for society as a whole, even though the agents have their own self-interests. It involves creating incentives so that all decision-makers face incentives to follow rules to achieve the desired outcome.
The “agents” referred to are people who are supposed to be working toward the best interests of the “principals” they work for. Hired managers are the agents of stockholders who are the principals in a corporation. Elected officials are the agents of the citizens who are the principals in a democratic society.
A “principal-agent problem” exists when there are incentives for self-interested hired or elected agents that motivate them to do things to feather their own nests at the expense of stockholders or citizens. Managers may concentrate on getting big pay packages rather than maximizing long-term shareholder value. Politicians may concentrate on getting re-elected or moving up to a higher-level office rather than crafting effective long-term government policies.
Mechanism design involves designing rules or institutions so that agents have incentives to work for the common good, despite their own self-interest. It isn’t easy, but Hurwicz’s work begins to point the way from situations as mundane as matching medical school grads with residencies to national ones like balancing budgets.
Finding incentives for self-restraint by self-interested people is central. Jon Elster, a much younger scholar whose interests are even broader than Hurwicz’s, examined that thorny issue in his 1979 book, “Ulysses and the Sirens.”
In Homer’s epic, “The Odyssey,” the sirens were beautiful women who sang songs so enchanting, mariners steered toward the sound of their music and were shipwrecked on the rocks.
Ulysses wanted to hear this supremely beautiful music. But he didn’t want to wreck his ship. He had his men tie him to the mast, so that he himself could not steer toward the sirens. The men plugged their own ears with wax, so they would not hear the seductive music. They rowed on, oblivious to the seductive songs and ignoring their leader, who begged to be released from his bonds. Elster, a Norwegian-born political philosopher who now teaches at Columbia University, examined possible incentives for similar self-restraint in various settings.
How can we tie Governor Pawlenty and legislative leaders of both parties in both houses to some mast of fiscal responsibility, so that they ignore the siren songs of national elective office or of political advantage in the 2010 elections?
One mechanism would be to make the state’s balanced budget requirement more flexible by requiring balance over some rolling three-year or five-year average. But it also could include a much larger budget reserve isolated from the siren calls of new spending programs or tax cuts.
Such isolation might come from an independent state fiscal board, modeled on the Federal Reserve Board or the Minnesota Supreme Court. The governor could be legally required to present a budget proposal that would have to be certified as gimmick-free by this board. Ditto for each house of the Legislature. No certification could be given to maneuvers like bonding against tobacco settlement revenues, privatizing public property to balance the government operations budget or shifting payments from one fiscal year to another.
No bill to establish new government programs above some threshold level or to raise or lower taxes could be enacted unless the independent board certified it could be implemented without endangering long-term fiscal balance.
Such an external referee would give political cover to elected officials to do the right thing, even when it offends their political bases. Just as Third World leaders can say, “I didn’t want to raise taxes and cut spending, but the IMF made us do it,” so Minnesota politicians could say “I fought for that new program (or tax cut) but the fiscal board vetoed it.”
These are just thoughts. There are ramifications to any substantial institutional change. But the ideas of Hurwicz and Elster give Minnesotans something to think about while games go on till late at night in the Capitol.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.