Low Power Incentives
By MortazaviBlog on May 24, 2006
Finally, I'm finished with my reading of Avinash K. Dixit's The Making of Economic Policy: A Transaction-Cost Politics Perspective, Munich Lectures in Economics (MIT Press, 4th printing, 2000).
In it, Dixit relies on his broad research and reading into the applications of game theory and economics to government policy making.
Dixit works in parts of an interesting paper from the works of Paul Milgrom. Milgrom has proven himself an authority in the applications of game theory to economics. In his research project, Milgrom shares many of the same problems studied by institutional economists such as Oliver Williamson and Douglass North. (I would certainly like to attend some of Milgrom's lectures at Stanford, if my time ever allows.)
Here's a quote from Dixit on Milgrom's work (The Making of Economic Policy, page 96):
Holmstrom and Milgrom find two important results. First, if the result
of one task is very poorly observable, then the incentive scheme for a
competing task must have lower power in order to avoid excessive
diversion of effort away from this task to more observable ones.
Second, if some tasks are primarily of value to the agent, and can be
controlled in an all-or-nothing fashion, then it may be desirable for
the principal to simply prohibit these, rather than try to give extra
incentives for others. This point is especially important if the
incentives for other tasks must be low-powered in conformity with the