On moral hazard


I have commented before on contradictory notions of modern economics.  Moral hazard, a favorite one in macroeconomics and financial economics, is one of those concepts that ticks me the wrong way.  The conventional story goes like this:

Some people know more (or different) than others about their mutual interactions and agreements (e.g. financial contracts) — you know, the interactions that create those structures we call society.  Self-regarding people who know something the others don’t “adversely select” themselves in or out of the interaction, which undermines the social fabric (e.g. financial markets, very finicky parts of the fabric of a modern capitalist society). After the fact, those covered by an agreement or social arrangement engage in riskier behavior than otherwise, because they don’t carry the full costs of their actions, and those holding the other contractual end are exposed.   Furthermore, insofar as any agreement with a chance of sticking will involve a tacit contract with the rest of society (this is usually embedded in a political constitution or its subordinate laws, whereby people are taxed to muster resources and enforce private contracts), bystanders will be exposed insofar as they are on the externality downstream resulting from a breach of contract.  And that’s supposed to be bad in general?

Let’s take a big step back.  Avoid the fallacy of composition — i.e. the idea that what applies to the individual case necessarily applies in general.  Isn’t moral hazard, at its most fundamental, the price of civilization? A group of hand-to-mouth tribal hunters and gatherers constitute a polis so they can save construction materials, time, transportation, energy, etc. by sharing space, defense expenses, etc. Individuals get hefty external benefits from the scheme (“increasing returns”) and all the bounty that flows from people helping people — which is to say, from people sharing productive wealth. However, their social insurance scheme is bad bad bad, because it encourages risky behavior by individuals, who won’t pay full cost for their recklessness, thus leading to the collapse of their little civilization?  And the alternative — staying scattered, bearing the full cost of there being individuals, fending for themselves against the hostility of nature — is supposed to be superior?  Those oh-so-worried about monetary policy and fiscal policy measures to get the economy a bit closer to its “long-run potential” (e.g. Wall Street Journal types), because it creates moral hazard, are full of it.  Think about it for a moment: Isn’t the consistent advocacy of “free markets” the denial of civilized life?  (And I am not saying that Wall Street Journal types are consistent in advocating anything other than their own narrow, myopic self interest.)

Or maybe it is the denial of any and all human life.  Let’s see: “Mom: Do not feed or protect your baby, because you’ll only be creating moral hazard.  The baby, as an individual, should get food for itself, or else it’ll grow used to excessive risk-taking at your and our expense.”  Isn’t “risk taking” what we call human life, taking purposeful action without full knowledge of consequences, and — therefore — going after uncertain benefits?  Come to think of it: There’s absolutely no social structure that, one way or another, does not constitute a sort of insurance policy.   Families, states, markets, clubs, etc. — insofar as they do not fail, insofar as they enable the cooperation among people — qualify as insurance contracts.  And don’t their failures result from breaching or renegotiating the contractual terms?  Why would self-regarding people enter into social relations if they didn’t extract a benefit from it?  What is private ownership is not a form of this, except that it benefits the owning class only, while drawing from the rest of society the resources to uphold it?  Where do your (allegedly “natural” or “God-given”) rights  of ownership come from if not from my obligations?  Where do your assets come from if not from my liabilities?

But isn’t there a moral case against freeloading?  Yes!  Exploitation, systematically appropriating social wealth at the expense of the majority of society, is despicable.  Experiencing how the wealth that you contribute to create (which, as Marx appropriately noticed, is ultimately the wealth of our social relations) becomes alien to you and empowers the class of freeloaders that exploit you sucks absolutely.  Talk about moral hazard!  Society, thanks to the combination of labor, creates this formidable productive force only to see how the 1% takes it over and uses it to their exclusive advantage.  Marx talked about how the human reaction against this moral hazard is the moral “categorical imperative” at the core of socialism.

Well, the issue is not moral hazard in general.  So-called moral hazard results from social cooperation, which is the basis on which the productive forces of human labor expand.  And this is the reason why humans form and stick to gregarious arrangements of various kinds.  The real issue is: moral hazard for whom.  Who is appropriating the upside that results from our association?  Who is receiving the rights or benefits and dumping on the rest of us the obligations or costs of the social arrangements that we form?  Who is truly appropriating the safety and shifting away the hazard for others to endure it?  Who is exploiting us?  How can we stop them?

So I figure that, as a general principle, I’m all for moral hazard.   The litmus test is: Is it the moral hazard that provides security to the 1% and a hazardous existence to the 99%, or the other way around?   Because it’s the former that we must reject.

1 Comment

  1. Does the landlord risk moral hazard when s/he passes the homeless on city streets?

    Not if s/he has made a tax deductible contribution to the Salvation Army after spending one night in a protected outdoor shelter with CEOs.

    Does the capitalist risk moral hazard when s/he urges representatives in the political State to cut funding for social welfare?

    No. Not if s/he contributes a few cans of food to the local Food Not Bombs collective.

    Such is the morality of narrow individualism, the dominant morality of our times.

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