Optimal Institutional Design: Rationality, Law & Economics 23 March 2010

Law & Economics (Dunoff and Trachtman) What means L&E? Why have international lawyers avoided law and economics? Methods (methodological individualism, rational choice) Non-economic values Denigration of IL What assets are traded? components of power (jurisdiction to prescribe, adjudicate and enforce) Gains from exchange? (externalities, economies of scale) IOs like firms?

Optimal Protection/Efficient Breach –3-step protection: –Entitlements protected as „inalienable“ –„Property“ –„Liability rule“

Rational Design of International Institutions Institutional design Assumptions: –Institutions are organized differently –States use international institutions to further their own goals, and they design institutions accordingly

Rational Design of International Institutions Dependent variable (Design Features): –Membership rules (restrictive/inclusive) (e.g. who belongs to the group) –Scope of issues covered (large/narrow) –Centralization of tasks (e.g. IMF collects, evaluates and publishes statistics on its members’ payments, WB specialists negotiate loans for economic or major infrastructure investments, GATT has no centralized power to punish/reward, yet centralized arrangements for judging trade disputes) –Rules for controlling the institution (e.g. rules for electing officials, financing, voting arrangements) –Flexibility of arrangements (e.g. escape clauses, GATT rounds of negotiation)

Rational Design of International Institutions Independent variable (explanations for variance): 1) Distribution problem (battle of sexes) 2) Enforcement problem (incentives to cheat) 3) Number of actors 4) Uncertainty –about behavior –about the state of the world –about preferences

Rational Design of International Institutions Conjectures M1:Restrictive Membership Increases with the Severity of the Enforcement Problem M2:Restrictive Membership Increases with Uncertainty about Preferences M3: Inclusive Membership Increases with the Severity of the Distribution Problem S1: Issue Scope Increases with Greater Heterogeneity Among Larger Numbers of Actors S2: Issue Scope Increases with the Severity of the Distribution Problem S3: Issue Scope Increases with the Severity of the Enforcement Problem C1: Centralization Increases with Uncertainty about Behavior C2: Centralization Increases with Uncertainty about the State of the World C3: Centralization Increases with Number C4: Centralization Increases with the Severity of the Enforcement Problem

Rational Design of International Institutions V1: Individual Control Decreases as Number Increases V2: Asymmetry of Control Increases with Asymmetry Among Contributors (Number) V3: Individual Control (To Block Undesirable Outcomes) Increases with Uncertainty about the State of the World F1: Flexibility Increases with Uncertainty about the State of the World F2: Flexibility Increases with the Severity of the Distribution Problem F3: Flexibility Decreases with Number

Rational design reconsidered Design or change? (Pathway to cooperation) What explains variance in scope over time? Mission creep… Do negotiations matter? (Narlikar and Odell 2006) Unintended consequences Satisficing behavior (bounded rationality)

Principal-Agency Theory Delegation is based on a contract Conditional grant of authority Limited in time, scope / can be revoked With delegation additional control features are designed (concern that agent follows own interests: agent slack): –Ex ante (choice of agent, screening, mandate) –On the spot (police patrol vs. fire-alarm) –Ex post (sanctioning)

Principal-Agency Theory Why delegate? Division of labor / gains from specialization Managing policy externalities Facilitate collective decision-making Resolving disputes Enhancing credibility Lock-in (creating bias)

Principal-Agency Theory Watch out on the Principal Side Preferences of Principals (heterogeneity) Multiple Principals Principal Costs (Flawed Mandates, Few Resources, Leap-frog)

Principal-Agency Theory Watch out on the Agent Side Preferences of Agents Agency strategies –stick to the mandate (work-to-rule) –use discretion given by design (gap-filling) –“exploit” autonomy (asymmetry-exploiting) –build buffer zones in case principals might react negatively in the near future (buffering).

Principal-Agency Theory Problem of observational equivalence Adverse selection Long delegation chains..

Example WTO: Delegation chain and various PARs