Principle-Agent Theory in Economic Development

Economic development is seen as a business and government partnership. The author’s Lombard and Morris (2012) analyze how the principle-agent theory can foster public-private partnerships and privatization to foster growth. They use a specific case example to help highlight their overall concept of cross-pollination. It is this cross-pollination that should help develop other projects within the area.

Local entities seek to increase their economic activity as well as the potential spill over benefits of additional employment. They look for and solicit businesses to move into their areas and develop productive capacity. In many cases using approaches such as an advantageous business environment and lower taxes helps nudge businesses to consider local investment. 

The authors use Virginia Beach, Virginia as their case study. The historically suburban city was struggling to create a vibrant business downtown business district. As the project started as a single government entity and a single private entity it was a simplistic way of studying the factors of development. The principle-agent theory appeared to be the most appropriate scientific lens. 

In the development of a public-private partnership the values and goals of the public become more important than individual goals. The principle-agent theory implies that one entity wishes for the task to be completed and the other agree to complete the task (Eisenhardt, 1989).That process can exist between government and company, doctor and patient, or contractor and subcontractor. 

When there is a partnership between government and business it is through an alignment of goals. Governments do not necessarily seek a profit but do seek to minimize costs and increase effectiveness through privatization. Companies that seek profits do so within the defined prices set by the government. A general bidding process can be used to determine interested parties. 

In the case of Virginia Beach the merging of two entities found that there was no core business district. Local decision-makers rezoned the downtown area and used an effective slogan such as “live, work, play” to sum up the genre of their location. Furthermore, they developed the downtown district by having the principle (i.e. government) using an agent (private business) to develop available parking other projects. The bidding process helps to ensure that competent companies compete to reduce the overall price. 

A number of key concepts fold into each other. Using a marketing slogan that sums up the goals of the area may be effective in pitching to future investors. The development of a downtown district helps in sparking increased investment and interrelated projects of growth. More importantly, government can encourage investments in particular areas by being both data rich and offer appropriate guidance in areas of necessary improvement. The principle-agent theory need not apply only to government funded construction but could also apply to potential promotion of areas where outside investment will likely be successful within the economic hub. 

Eisenhardt, K.M. (1989). Agency theory: An assessment and review. Academy of Management

Review, 14(1), 57–74.

Lombard, J. & Morris, J. (2012). Using privatization theory to analyze economic development projects. Public Performance & Management Review, 35 (4).