Bureaucracy and adverse selection

Observing layers on layers of procedures and formalities in government bureaucracy for the past 7-8 years, I have often wondered as to why it needs to be so rigid to the point of being stifling. (I have limited experience of private bureaucracy to comment on it) All of us are aware that procedures and processes are only the operational infrastructure for achieving certain specified objectives of the Government. But bureaucratic systems often tend to elevate and see the means as ends in themselves, thereby defeating the very purpose of having in place those rules and regulations.

There are a number of theories which seek to explain and analyse the functioning of any bureaucratic system. These theories range from those of Karl Marx to Max Weber, Rational Choice to Public Choice schools, and the more recent ones invloving interest groups and pressure groups. Into this multi-dimensional debate, my personal experiences suggest that the "adverse selection" analysis is appropriate. It will highlight the crucial adverse selection problem in the interaction between the layers of the bureaucracy. This problem breeds suspicion and apprehension among agents, thereby necessitating and even justifying the mitigating mechanisms of the rule-book.

Nobel Prize winning economists George Akerloff and Joseph Stiglitz, conceptualized the "adverse selection" problem as arising from an inability of the market to recognise "lemons". A lemon is a defective item put up for sale. The presence of lemons throws up interesting possibilities in certain markets like those for used cars and insurance. Both these markets suffer from what economists call "assymmetric information" related problems. The sellers in these markets - used car owners and insurance claimants - have more information about the commodity on sale, than the buyers. For example in a used car market, in the absence of full information about the quality of the car, the buyer will be unwilling to pay the full price for even a good condition car. Similarly, sellers of good cars will be hesitant to put up their cars for sale since even good cars are likely to trade only at a discount. This dual effect is likely to see the market being occupied more by lemons than good quality products, thereby further deepening the information assymmetry problem.

A bureaucracy too suffers from an acute problem of this adverse selection. Government transactions are institutionalised by way of layers of procedures and processes, and elaborate file work to capture the same on record. Among other things, this is necessary to ensure consistency in policy and decisions, reduce subjectivity and individual biases, facilitate monitoring and supervision, maintain records for future reference and limit rent-seeking opportunities. They help protect the system from both the willful and involuntary actions of the lemons or rogue individuals.

Let us imagine every transaction in government - file approvals, decisions etc - as an interaction between two layers of the bureaucracy, involving sub-ordinates and the supervisor or the principal and agent(s). Like in the case of insurance, where the presence of lemons increases the transaction costs, in bureaucracy lemons contribute towards making it more rigid and rule oriented. Lemons act with different motivations - malafide intentions, ignorance of rules and processes, over-enthusiasm and haste, and even plain incompetence. Given the presence of lemons, prudence demands that the principal and the agents look at every transaction with great caution. This atmosphere of suspicion, necessitates the validation of processes and actions at every step.

In fact, one could say that the most immediate and in many ways the most important concern for any official is the need to protect himself from the consequences of actions of other agents in the system, especially those with suspect intentions. This caution gets institutionalized and translated into a set of formal procedures and processes, captured typically in a set of file notings. In a way, this standardization tries to bridge or mitigate the assymmetry in information betwen the official and the lemon. In the absence of any mechanism to screen the lemons, agents see a potential lemon at every step, and see all transactions with the same level of caution. Once caution becomes the by-word, procedures and formalities come to fore, as individuals try to hedge their risks by submerging the process in a sea of bureaucratic procedures and formalities. Therefore one could even say that in the absence of adverse selection, a significant rationale for inflexible bureaucratic procedures would cease to exist.

Since adverse selection is a reality, we need take steps to limit the problems arising from it. Akerloff and Stiglitz argue that this requires reducing the assymmetry in information. This in turn calls for putting in place effective signalling mechanisms which can eliminate or atleast bridge this information gap. The agents (sub-ordinates) ought to be looking for every opportunity to signal their intentions and message to the principal (supervisior), who in turn should be receptive to the signals coming from the agents. These signalling mechanisms should work continuously and on multiple channels within the system. It should involve a mixture of both the formal and the informal.

The informal channels rest mainly on the bonds of trust and reciprocity in relations between individuals in each layer. The principal should be accessible to the agents at all times. Healthy work place relationships between the principal and agent, regular informal briefings, mentoring programs, etc can contibute susbstantially towards developing mutual trust. It is necessary to actively promote development of social capital within the organization or department.

The formal channels, consisting of institutionalised networks have an equally important role in eliminating this information assymmetry. Regular meetings, standardizing reporting formats and information flow, and inspections can go a long way towards bridging any gaps between layers. Internet and its numerous social networking technologies like bulletin boards and blogs are also powerful tools in facilitating free flow of information and reducing the assymmetry. For example, regular interactions through a common website can help agents in different layers understand each other better and help disseminate information across large sections of the system.

It is only by keeping open vibrant and continuosly active interaction channels across bureaucratic layers that the information assymmetry can be bridged and trust developed. This can then be leveraged by both the principal and agents to cut through the bureaucratic maze and expedite service delivery. At least wherever the interaction is free from adverse selection, the red tape can be curtailed. I am sure many of these channels are active and vibrant in corporate bureaucracies, and it may be a partial explaination for the lower level of red tape.

My objective by way of this analysis was only to highlight a critical area of concern in the interactions between the principal and agents in a bureaucracy and why we need to contain this. If we are to overcome this red tape we need to get beyond this mind-set and set up multiple signalling mechanisms, both informal and formally institutionalized, within the bureaucratic system. This will assure and comfort principal and agents in a system about the intentions behind each others actions. Ultimately each interaction has to find its mutually comfortable level of working relationship, which in turn will have to be adapted to the existing bureaucratic environment.