The notion of adverse selection has been prevalent as a political quandary at least since Plato, who observed: "The city where those who rule are least eager to do so will be the best governed." Politicians in every society are considered dubious because the individuals most attracted to politics might not be the most desirable rulers. Indeed, one might infer that it is perhaps those most likely to abuse any authority given to them that are most likely to be drawn to the political realm.****

IN a democracy, the role of electoral process is twofold: select the benign politicians (serving public interest) and discipline the malign politicians (rent seekers or wheelers and dealers) if they are elected. The malign politicians are entrenched in a conflict of serving interest of family, friends, party functionaries, and not those of the governed. If incumbents are identified as wheelers and dealers they are voted out of office in their re-election bid. However, false and fabricated information about candidates easily generates distortions in electors' behaviour and hence there is no guarantee that under benchmark reasoning a benign government would emerge from the electoral process.

The idea that free market economy always produces the best outcome relies on the assumption that what comes to pass in a market is known to all participants. But what happens when knowledge is imperfect, that is, when asymmetric information exists, where one side of an activity has more information than the other side? This is a pervasive feature of real world markets, which considerably affect how they operate. George Akerlof, Michael spence and Joseph stiglitz won the 2001 economics Nobel Prize for their path breaking insights into how markets operate and fail.

The literature is divided into adverse selection, which embodies the upshot of misinformation (that is, hidden information), and moral hazard, which represents the hidden (previously undisclosed) motives consummated after the selection was made.

Adverse selection occurs when one party engaging in an activity (say, a car buyer, a banker, a voter, etc) fails to recognize certain relevant characteristics such as honesty of the other party (a used car dealer, a borrower, a political candidate, etc). Under conditions of asymmetric information the former would fall prey to a deception by the latter in an activity they planned to engage in. Hence when an individual or an institution acts based on less than full information, the consequences of adverse selection will set in.

Moral hazard (undesirable outcome) occurs whenever there are inducements for agents, who cannot be easily observed or monitored, to behave in a manner contrary to what is expected of them after being selected. The source of this moral hazard problem is, as with adverse selection, an asymmetry of information. An example of both adverse selection and moral hazard in the context of Bangladesh is the colossal amount of bank loan defaults.

Application of the concepts of adverse selection and moral hazard in politics boils down essentially to a game of incomplete information between political candidates (agents) and representative voters (principles) -- a classic principal agent problem.

In selecting agents in a democratic process, principals want qualified candidates who would work in public interest. If the inducements are large it will inveigle a large number of candidates, some with inadequate qualification and aptitude for the job thus bringing into play the dilemma of adverse selection. Identifying qualified candidates against the shady ones is possible only if qualifications and virtues are easily discernible. The problem, therefore, is one of knowing the traits and motivations of the candidates.

The notion of adverse selection has been prevalent as a political quandary at least since Plato, who observed: "The city where those who rule are least eager to do so will be the best governed." Politicians in every society are considered dubious because the individuals most attracted to politics might not be the most desirable rulers. Indeed, one might infer that it is perhaps those most likely to abuse any authority given to them that are most likely to be drawn to the political realm.

Moral hazard arises when the principal cannot, after entering a contract, fully observe the agent's actions that may affect the outcome. A political analogue is that once elected, and elevated to executive position, politicians face

a myriad of lures. The most innocuous such lure may be to use their authority to advance their own personal agenda, rather than the platform on which they were elected. A more baleful possibility is that politicians use their offices and influence covertly for personal gain or to benefit their families, friends, and business associates, as in Bangladesh.

To the extent that corruption fostered by moral hazard looms as a political problem, it is likely to be systematically related to two important parameters of the delegation relationship.

First, the greater the discretionary power politicians are granted, the more reckless they become in misusing their power for personal gain.

This may explain why, as susan Rose-Ackerman argues, "political corruption is such a depressingly importunate feature of the world's poorest countries, regardless of the promises that may surround new officeholders. For those who wish to 'better themselves' financially there is simply no alternative to rent-seeking political participation.”

second, the longer incumbents stay in office, the more serious the moral hazard problem may become.

That is because becoming corrupt is a bit like losing one's virginity; there is no going back, the inertia of rent seeking continues unabated. Unfortunately, honest politicians in the system may become corrupt over time, but corrupt ones rarely become honest. This is probably the best argument in favor of term limits for lawmakers, which otherwise may have undesirable consequences for electoral accountability.

The voters of Bangladesh are in adverse selection trap and escaping this trap has become insuperable challenge partly because: l Most voters are generally nonpolitical and easy to fleece.

l People who are groomed to become politicians while being students are the ones who often lacked the ability to succeed

elsewhere.

l These politicians are often inexplicably willing to sacrifice honesty and moral callings.

l The voters are limited by choices of desirable alternatives.

l A vast majority of our lawmakers are political neophytes listed as businessmen who often use money and official power to dupe voters.

The existence of adverse selection in our political process is well known far and wide. While the WB, IMF and other donors have no business to meddle in our affairs, they have, however been trying to minimize the moral hazard problem that is holding back our Poverty Reduction strategy (PRs) and overall economic progress.

At the PRs Forum press conference on November 17, WB Vice President Praful Patel explicated, "We told the government very frankly we have become really exasperated hearing time and again that such and such law or commission is in the offing, while the corrupt people are not prosecuted"

The WB recently has called off loans worth Tk 68 million against three projects on grounds of sleaze and asked the government to recompense the money already spent against these loans. This is a classic case of imposing "stick and carrot" discipline by the WB to curb the moral hazard problem that has engulfed virtually all private and public sectors.

Addressing the discussion on "WB Bank's role in the Private sector Development of Bangladesh, the WB Country Director Dr. Christine Wallich on November 20 remarked that compared to India and Pakistan, Bangladesh is more corrupt, justice is worse and education is lagging behind in comparison to India. she recommended that the NBR as well as the PsC be reformed.

Advice to reform the PsC is not in the domain of the WB. However, being an economist, Dr. Wallich knows that BCs exam questions leaking are an archetypal case of adverse selection (least qualified candidates' desperate bid to sneak

into prized civil service). The country will suffer the consequences of moral hazard if they finally get into this highly selective service. Tk 300 billion bank loan default is a classic example of both adverse selection and moral hazard in the business of banking.

The Tuesday Group of diplomats attempt on holding a convention on free and fair election was frustrated by the ruling party on grounds of interference in country's internal affairs, whereas the admonitions and directives of the WB and IMF about grafts and prosecuting the corrupt were joined in by the Finance Minister himself. Might the hidden reason be that knowledge about fair election process (some deterrence against adverse selection) may cost votes to the ruling party whereas WB and IMF's "stick and carrot" stipulation on funds release, although undesirable, may bring votes in favour?

What recourse there is to minimize the twin dilemmas of adverse selection and moral hazard? There is virtually no alternative to a responsible free media and transparency as the foremost resort. Politicization of any form in any branch of the government must be made taboo. BCs exam results if tainted by questions leaking must be declared null and void. Political candidates must put out their qualifications, skills and lifetime records of all activities for public scrutiny and media synthesis and all political parties must expouse this novelty effusively if our democracy is to survive and a benign government to come into being.

Living with adverse selection and moral hazard as our way of governing for all these years has bestowed the scourge of most corrupt country ranking on us. This will not fade away during Hasina and Khaleda's lifetime, although they have profusely contributed to it.

The author is Professor of Economics, Eastern Michigan University, USA, presently visiting Bangladesh.