How much SHOULD Blagojevich have asked for?

Rod Blagojevich has been caught exploiting something given to him by the Illinois legislature – his right to appoint the state’s next senator. But isn’t he just doing what economics orthodoxy says he should – making sure the position goes to whoever can create most value from it?

Ronald Coase demonstrated that the seat will go to the person who values it most in any case – the only question is who has the property rights and therefore who will get paid for it? Now, Coase does exclude transaction costs from his analysis and there is certainly the potential for Blagojevich to incur a very high cost for this transaction. But in principle, selling the seat is not (economically) a sin. The doubtful aspect of what he has done is to appropriate the benefits of selling the seat to himself, instead of letting them be distributed to the media and electorate of Illinois via the campaigning process.

But what I want to know is: how smart was Blagojevich? How much is a Senate seat worth and was he going to get himself the right price?

There are various ways to answer this question.

1. Discounted cashflow. 

We can analyse the expected value of the seat by looking at the salary of a US Senator, the expected length of term, and the other benefits that accrue to the holder of the office, and comparing them to the expected earnings that the holder would have achieved without the appointment. A senator is paid $169,300 per annum. Fully 62% of appointed senators lose their position or do not stand at the next election and the average length of service for senators elected in the second half of the 20th century is 12.5 years (interestingly, this compares to only 8.5 years for the first half). So the expected length of term is around 62% of 2 years plus 38% of 12.5 years – a shade under six years. Working out an appropriate discount rate is tough in the current market but choosing 2.45% (the price of a 10-year Treasury bill and reasonably close to the long-run GDP deflator) we get a figure of about $955,000 dollars for discounted salary.

We can compare this to the candidate’s existing expected earnings over the same period – some candidates were members of Congress (with the same salary as a senator), one was a state senator ($67,833) and one a lawyer (probably earning more than a senator already). The state senator (Emil Jones) is 73, but it isn’t unusual for senators to stay in office well into their eighties, so I don’t adjust the expected length of term for him. The incremental salary for him therefore is $572,000 assuming he would have otherwise retained his state senate seat. As it happens, he had actually announced his retirement prior to recent events, so the value to him of the seat is closer to the $955,000 figure.

However salary is not the only material value of a seat in the Senate. The first and less significant benefit is pension. The discounted value of pension rights are heavily dependent on the age of the candidate and their likely length of service, but these are funded primarily by deductions from salary, so the value in addition to the salary figure is not substantial (the Club for Growth does ascribe a high value of $1.8 million to pension rights but they have taken account of neither how these are funded nor the opportunity cost of existing pension rights).

More significant is enhanced earnings after leaving politics. A recent paper by Eggers and Hainmueller analyses the value of office to British Members of Parliament and concludes that Conservative members earn approximately an additional £1 million during their lifetime compared with equivalent people who were not elected – with a cleverly chosen control group of people who were narrowly defeated in parliamentary elections. Labour Party members do not seem to benefit the same effect, which the authors ascribe to greater organisation and control by trade unions. Similarly, Diermeier, Keane and Merlo (2005) find that the value to a sitting US Senator of retaining a seat is around $1.6 million including monetary and non-monetary benefits. They do not calculate the value of the seat to a non-senator, so there is likely to be a value already gained by initial election to the Senate which is not reflected in this figure. Based on the doubling of lifetime wealth estimated in E&H’s paper, we could hypothesise a doubling of post-political salary for the average senator. DKM derive a 17% increase as a result of the first re-election, giving a 70% increase from initial election. Thus the $1.6 million value in situ is dwarfed by the approximately $6.5 million value of the first election. Intuitively this seems reasonable – the prestige of having a Senator on your board is arguably more important than how many terms they have served.

Again we may want to reduce this based on an “appointment discount” where an appointed senator who loses their seat at the next special election will not receive all the benefits. We have little data to base this on, but if the seat value is reduced by, say, two thirds for those who are not re-elected, the net value of the seat is $3.8 million.

2. Market price.

We believe that one candidate was offering $500,000, another was offering $1 million and a third was offering “nothing but appreciation”. We don’t know what the President-Elect’s appreciation is worth, but apparently it’s less than $1 million. Given that there is a monopoly supplier of this position and a limited number (1) of the commodity available, the highest price offered by any buyer is the one that will clear the market. So on this method, $1 million is the answer.

However, other Senate candidates have paid much more for their elections – for example Jon Corzine for example spent about $63 million of his own money to achieve election to the Senate. Again we might reduce this by the “appointment discount” leaving about $24 million.

That fee was perhaps paid at a peak in the Senatorial market, and by a non-price sensitive buyer. This year, according to the New York Times, around $100 million was spent on the 35 Senate races – a combined average of $3 million per election for both candidates (the average Democrat spent $2 million to $1 million for the Republican). However only about 12 races were genuinely competitive, so spending in safe states was likely to be lower. Therefore the market price of a new seat is up to three times higher than the $2 million Democratic spend.

3. Marginal returns. 

Finally we need to consider the marginal value of this one seat, given that all the others except Minnesota have already been allocated. With the Democrats holding the presidency and controlling the House, the 60-seat threshold in the Senate is crucial. A senator controlled by, say, the banking or automotive industry could extract immense rents from the state by voting for or against cloture on a bailout vote. In the current environment there are likely to be hundreds more opportunities in the next two years alone; re-election is virtually an afterthought in this context.

With $350 billion of the TARP still to be released by Congress, a $15-100 billion automotive bailout in the works, and a $500-600 billion fiscal stimulus to be designed and released, the influence of a swing senator surely must be worth tens of billions of dollars. Just how “swing” this senator will be depends on the result of the ongoing recount and ballot challenges in Minnesota. Recent rulings favourable to Franken, the Democrat in that race, make it more likely he will win and increase the weighted value of the Illinois seat. Imagine Blagojevich offered it to a Republican! This measure surely gives us the highest of the three values – I will conservatively estimate it at $1 billion.

The price

What was Blagojevich’s asking price? The market had not yet cleared, so presumably Blagojevich wanted more for the position than he had so far been offered.

Reportedly he wanted his wife appointed as head of a newly established charity which would pay her $100-150,000 per annum. No doubt she has an existing economic value so this would not be pure additional income. But it seems plausible this job was meant to be a sinecure and not a full-time post – otherwise why would he be so keen on it? If we take the average of $125,000 and discount it by a third to reflect the opportunity cost of taking the position, and assume a ten-year lifetime discounted as above, the price was $746,000.

Alternatively, he was looking for an appointment to cabinet as Secretary for Health and Human Services. This has a salary of $181,300 which discounted over a four-year period is worth around $737,000.

Given the figure of $1 million being discussed as the amount one of the candidates could “raise”, it seems likely that this discount represents the transaction cost of receiving the payment in a way that would provoke less suspicion.

However, why the huge discount to the potential multi-billion dollar value of the seat under the “marginal returns” scenario? Some possible explanations:

  1. The discount for risk of discovery is bigger than we think. It is estimated that the discount on fencing of shoplifted items, for comparison, is around 90%. Unique items such as major artworks tend not to be sold but instead ransomed (seemingly 5-10% of face value is again typical); so it would perhaps have been an option for Blagojevich to threaten to appoint a Republican or other “unacceptable” person unless rewarded.
  2. The property right is not defensible. The Illinois legislature is now deciding whether to strip the governor of his power to appoint; the Senate itself can expel a member of whom it does not approve; and the appointed senator may themselves not act in accordance with any prior agreement. All of these factors tend to devalue the item.
  3. Repeated iterations. In the ultimatum game, prisoner’s dilemma and numerous other tests of rational decision making, the optimal choice for a single game may not be the same as for a repeated game where your relationship with the other party will continue. More prosaically, companies sometimes choose not to extract the highest possible price from a customer in order to preserve long-term loyalty.
  4. Blagojevich didn’t know the value of what he had. Is it possible that he didn’t think of the possible value of the seat to an automotive company or a major bank?
The final possible conclusion, which I’m sure you’ll agree with, is that Rod Blagojevich was just too honest to sell the seat for its maximum possible value. Anyone who’s been in business for a while will have had a desperate customer who would have paid well over the odds for your services...and been just too squeamish to actually charge that much. It's pleasant to imagine that the governor was just ethical enough for that. What do you think?


Anonymous said…
He should have just put in on e-bay
Anonymous said…
A senators term is 6 years, not two. So the value should be 62% of 6 years and 38% of 12.5 years. Which adds even more salary value.
Kosmo said…
"A senators term is 6 years, not two."

True, but this particular seat is up for election in 2010 - thus the 62% chance that the appointee would serve just two years.
Anonymous said…
Thanks for the clarification.

However, I think it would be a fairly safe bet that the Democratic Blago appointee would have been re-elected in Illinois had Blago not found himself in trouble.
Anonymous said…
Obama's "appreciation" may be worth far in excess of $1m...
CW said…
Why didn't Blagojevich simply call a Loop law firm and to be made a partner and for his wife (if a lawyer) to be made a lawyer?

Unknown said…
I find it hard to believe that Blagojevich really thought very hard about the worth of this seat at all. He just knew that it was, "f&*#*$g golden!" If he would have actually tried to determine the amount of gold he had, he may have then understood that he ought to use a little discretion in trying to sell it. I mean if it was fairly obvious to him that there was a potential for personal gain through a favorable appointment, wouldn't it also be obviously something that would be closely watched, and therefore would require more stealth in trying to get a shady deal done. I mean it's one thing to inept, it's another to be dishonest, but to be both and somehow have made his way into that post is just unbelievable.
Anonymous said…
Your calculations fail to account for the value of expected employment post-office or for the huge amount Senators make from trading on (never wrong) tips on the stock market.
He probably should have added the risk cost of eight years of sharing a cell with Bubba the male rapist.
Anonymous said…
Jesse - I think you hit it on the head. Most criminals are stupid. Evidently, Blagojevich is no exception. Actually expressing such thoughts over a PHONE is about as bright as a tagger signing his handiwork.
Anonymous said…
...but Obama is pretty smart.
The Internet said…
The $2 MM discount explains why Jesse Jackson Jr. was crying tears of joy at that breakfast meeting

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