Pakistan in the US Strategic Lens

It’s not often realized that many of the insights on politics as studied in the social sciences are drawn from theories of the firm.  Far from being a criticism, theories of the firm have helped to produce some very valuable general understandings of organizational behavior.  Much of these insights have been incorporated into rational choice and game theory based “new institutionalist” theories of states, empires, parties, etc.  (See occasional 3QD contributor Alex Cooley’s Logics of Hierarchy for an lucid use of the approach.)  In n+1, Jules Treneer gives us quite a tour through new institutionalism in a look at US-Pakistani relations:

[T]he White House has been attempting to manage its relationship with Musharraf according to the logic of a specific class of economic game, which economists call the “Principal-Agent Problem.” You give your money to someone; how do you know they will manage it with your interests in mind? The answer, according to economic theory, is to make sure the incentives of the principle and the agents are aligned. Though elegant in concept, this game-theoretical approach proves thorny, because aligning the interests of independent actors is not all that straightforward. Among other things, there is the problem of information: How does one measure an agent’s performance? Quantitatively? Qualitatively? Over what length of time? The choice of the wrong benchmark or time frame can lead to all sorts of perverse outcomes.

Take Merrill Lynch. The financial giant recently let former CEO Stan O’Neal walk away with $250 million in compensation based upon short-term measurements of its stock price, which rallied in part due to the $25 billion in pretax profits O’Neal helped generate during his tenure as CEO. The problem, and the reason O’Neal was shown the door, is that the $25 billion was illusory. Though not alone in suffering credit-related losses, the write-offs Merrill Lynch will be forced to take this year – a direct result of strategies O’Neal aggressively pursued – may amount to $16 billion or more. If Merrill had made only $9 billion in pretax profits over the same period, the stock’s performance would have been less spectacular, and O’Neal’s compensation less spectacular as well. Put another way, if Merrill had measured O’Neal’s performance over the proper time frame, he would have earned much less.

Is it worthwhile, then, to think about the US relationship with an autocrat like Musharraf in terms of the Principal-Agent problem?

[H/t: Asad Raza]

UPDATE 3/24/08: My response to Treneer’s article is here at n + 1. –Abbas Raza.