Why Politics is More Fundamental Than Economics

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.