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We provide an explanation for why both college tuition and government grants to college students are typically means-tested. The critical idea is that attending college is both an investment good and a consumption good. The consumption benefit from education implies that, when tuition and grants are uniform, the marginal rich student is less smart than some poor people who choose not to attend college, thus reducing the social returns to education and increasing the college's cost of education. Competition in the market for college education results in means-tested tuition. In addition, to maximize the social returns to education government should means-test grants. We thus provide a rationale for means-tested tuition and grants which relies neither on capital market imperfections nor on redistributive objectives.

A worker's utility may increase in his own income, but envy can make his utility decline with his employer's income. Such behavior may call for high-powered incentives, so that increased effort by the worker little increases the income of his employer. This paper employs a principal-agent model to study optimal incentive contracts for envious workers under various assumptions about the object and generality of envy. Envy amplifies the effect of incentives on effort and, therefore, increases optimal incentive pay. Moreover, envy can make profit-sharing optimal, even when the worker's effort is fully contractible. We discuss several applications of our theoretical work. For example, envy can explain why lower-level workers are awarded stock options, why incentive pay is usually lower in non-profit organizations, and higher in larger firms. Envy may also make governmental production of a good more efficient than private production.

Civil servants have a bad reputation of being lazy. However, citizens' personal experiences with civil servants appear to be significantly better. We develop a model of an economy in which workers differ in laziness and in public service motivation, and characterise optimal incentive contracts for public sector workers under different informational assumptions. When civil servants' effort is unverifiable, lazy workers find working in the public sector highly attractive and may crowd out workers with a public service motivation. When effort is verifiable, the government optimally attracts motivated workers as well as the economy's laziest workers by offering separating contracts, which are both distorted. Even though contract distortions reduce aggregate welfare, a majority of society may be better off as public goods come at a lower cost.

We study electoral competition among politicians who are heterogeneous both in competence and in how much they care about (what they perceive as) the public interest relative to the private rents from being in office. We show that politicians' incentives to behave opportunistically increase with politicians' pay and with polarization of policy preferences. Moreover, politicians may have stronger incentives to behave opportunistically if other politicians are more likely to behave opportunistically. A political culture may therefore be self-reinforcing and multiple equilibria may arise. Lastly, we show that the mere probability that politicians care about the public interest enables opportunistic politicians to damage the reputation of their competitors. Consequently, efficient policies may be reversed.

We analyze a simple model of local public good provision in a country consisting of a large number of heterogeneous regions, each comprising two districts, a city and a village. When districts remain autonomous and local public goods have positive spillover effects on the neighbouring district, there is underprovision of public goods in both the city and the village. When districts unite, underprovision persists in the village (and may even become more severe), whereas overprovision of public goods arises in the city as urbanites use their political power to exploit the villagers. From a social welfare point of view, inhabitants of the village have insufficient incentives to vote for unification. We examine how national transfers to local governments can resolve these problems.

We argue that promoting education may be a means to re- duce income inequality. When workers of different skilllevels are imperfect substitutes in production, an increase in the level of human capital in the economy reduces the return to education and, hence, pre-tax income inequality. The compression of pre- tax wages implies that a given inequality of after-tax incomes can be reached with a less progressive income tax. Optimal redistri- bution policy faces a trade-off between the distortionary effect of progressive income taxation and the distortions arising from education subsidies. The optimal level of education subsidies cru- cially depends on the extent to which education compresses the wage distribution, the distortionary effect of progressive income taxation, and the political desire to redistribute income. We dis- cuss empirical evidence showing that the economy's average years of schooling has a strong effect on pre-tax income inequality. We compute for a number of OECD countries the level of education subsidies that could be justified on redistributive grounds. Our argument for education subsidies goes a long way towards ex- plaining the actual pattern and level of education subsidies in OECD countries.

Trade unions tend to reduce the dispersion of wages among their members. Skilled workers may therefore have an incentive to separate from an encompassing union and organize into a separate craft union. In this paper, we examine a theoretical model to gain insight into the determinants of the number of trade unions at a firm. We show that imperfect competition in the product market may drive skilled and unskilled workers together, even though unskilled workers use their political power in the trade union to extract rents from the skilled workers. Additionally, we examine the influence of several features of production technology on trade union structure.

The collection of information necessary for decision-making is often delegated to agents (e.g. bureaucrats, advisors, lawyers). If both the pros and cons of a decision have to be examined, it is better to use competing agents instead of a single agent. The reason is that two conflicting pieces of information cancel each other out. Using two agents, each searching for one cause yields full information collection at minimum costs. This provides a rationale for advocacy in political and judicial systems. In this paper, we provide a rationale for the sequential nature of information collection in advocacy systems. If two agents search simultaneously, the incentive to continue searching is affected by the information found by the other agent. This forces the principal to leave rents to the agents. If agents search sequentially, the reward can be made conditional on the information found in earlier stages. This reduces the cost of information collection. However, sequential advocacy implies either a more sluggish decision-making process or a less-informed decision.

Centralisation of political decision making often fails to produce the desired results. For instance, it is frequently argued that decision making within the European Union results in overspending and overregulation in some policy areas, while too low spending and too little regulation prevails in other policy areas. In this paper, we study a model in which delegates from jurisdictions bargain over the amounts of public goods provided by jurisdictions. Following Besley and Coate (2000) we show that local policy makers have an incentive to delegate bargaining to 'public good lovers' if all the cost of public goods are shared through a common budget. Consequently, overprovision of public goods results. If a sufficiently large part of the cost of public goods can not be shared among regions, underprovision of public goods persists under centralised decision making because local policy makers delegate bargaining to 'conservatives'. Underprovision is strongest when spillover effects are moderate: both in the absence of spillover effects and in the case of global public goods, centralised decision making produces the social optimum. Finally, we study financing rules that may help to avoid strategic delegation by local policy makers.

Should education be subsidized for the purpose of redistribution? The usual argument against subsidies to education above the primary level is that the rich take up most education, so a subsidy would increase inequality. We show that there is a counteracting effect: an increase in the stock of human capital reduces the return to human capital and, therefore, pre-tax income inequality decreases. We consider a Walrasian world with perfect capital and insurance markets. Hence, in the absence of a strive for redistribution, the market generates the efficient level of investment in human capital. When there is a demand for redistribution, the general equilibrium effects on relative wages might make a subsidy to education an ingredient of a second-best optimal redistribution policy. Stimulating human capital formation results in a compression of the wage distribution, and hence reduces the need for distortionary redistributive taxation. We also study the political viability of education subsidies.

To reduce the chances of policy failures, policy makers need information about the effects of policies. Sometimes, policy makers can rely on agents who already possess the information. Often, the information does not exist yet. This raises two questions. First, how much resources should be devoted to the production of information? Second, should information be produced by a profit- maximizing firm (a private consultant) or by someone who has an interest in policy outcomes (a political adviser)? This paper shows that policy makers may prefer hiring a political adviser for two reasons. First, in contrast to a private consultant, a political adviser need not be fully compensated for exerting effort. Second, a political adviser with moderate preferences produces information of a higher expected quality than a private consultant is induced to do by the optimal monetary incentive scheme. The cost of hiring a political adviser is that she may distort policy decisions by manipulating information. As long as a political adviser is not too biassed, the policy maker prefers consulting a political adviser to consulting a private consultant, even if a political adviser and a private consultant are equally costly. Competition among political advisers is shown to reduce the willingness of political advisers to produce information.

After decades of government growth, Western countries have witnessed major policy reversals. Prominent examples include the far-reaching policy reversals implemented by Thatcher, Reagan, and Douglas. This paper offers an explanation for these policy reversals. Our key argument rests on the assumptions that public decisions are made by majority rule and that voters have incomplete information about the aggregate consequences of all possible bundles of public projects making up the government. Unlike existing explanations, our theory is consistent with the observations that policy reversals are often undertaken simultaneously and that separate parts of the package of policy reversals are not welcomed enthusiastically by voters.

Resistance to socially desired reforms may arise from uncertainty about the consequences of reforms at the individual level (Fernandez and Rodrik, 1991). Without a binding commitment, a promise to compensate losers will not raise support for reforms due to a credibility problem. This paper shows that voting simultaneously on several reforms may solve the credibility problem. It is argued that the governmental agreement in the Netherlands has served as a means to vote simultaneously on several reforms and has helped breaking political deadlocks. Moreover, our model provides an explanation for some perceived changes in the Dutch policy making process.

A firm may induce voters or elected politicians to support a policy it favors by suggesting that it is more likely to invest in a district whose voters or representatives support the policy. In equilibrium, no one vote may be decisive, and the policy may gain strong support though the majority of districts suffer from adoption of the program. When votes reveal information about the district, the firm's implicit promise or threat can be credible.

Uncertainty about the future preferences of the government may induce policy makers to run excessive budget deficits. As a solution to this problem, economists have proposed to impose a binding debt rule. In this paper we argue that a binding debt rule does not eliminate the distortions due to strategic behaviour of politicians. Rather, strategic manipulation shifts from public debt to public investment. As an alternative, we examine the effects of a capital borrowing rule which permits the government to run a budget deficit equal to the amount of public investment. We show that this rule effectively eliminates strategic behaviour.