The Paternalist as Principal: Why Information Asymmetry Limits 'Care from Above'

Why can one not "simply choose the best option for a person"? Because you do not know who is in front of you.

Intuition: a guardian who cannot see whom they are guarding

The principal (the planner) wants "correct" behaviour from agents, but their type — abilities, willpower, tastes — is hidden private information; only actions and outcomes are observable (The Theory of Incentives).

Formalism: hidden types

The canonical example is James Mirrlees's model of optimal income taxation: the government cannot see people's productivity and builds a tax schedule so that the highly productive do not "pretend" to be low-productive (Review of Economic Studies). This is a problem of adverse selection in its purest form.

Incentive compatibility

A guardian mechanism works only if it is advantageous for every type to behave according to its true type rather than imitate another (incentive compatibility). Otherwise the paternalistic "help" is destroyed by strategic behaviour: people adjust to the rule rather than to its intent.

Information rent

To respect the self-selection constraint, the planner sacrifices part of the efficiency — some of the gain goes to the agents as "information rent." This is precisely the price of not knowing preferences: perfect guardianship is unattainable not because of ill will but because of the structure of information.

Conclusions

From this follows an important corollary for the whole site: since the paternalist does not know preferences, they cannot directly choose the best option for a person — they can only design a menu or contract in which people reveal their type through their own choices. And when agents also err in assessing their own future (internalities), the problem combines hidden type with hidden irrationality — and "perfect paternalism" becomes logically impossible.