Thoma and Delong both linked to Summers' FT column with this title yesterday. Summers has in mind the trade-off between stability and moral hazard that a lender of last resortmust negotiate. Fundamentalists look at the moral hazard costs of such policies (people take inefficiently high risks, knowing that they will be bailed out) and ignore the benefits of insuring that solvent debtors are not brought down in a panic: they see no trade-off at all. It's as if, he says, we argued that because the presence of a fire-house down the street makes us somewhat more likely to smoke in bed, that therefore there should be no firehouses!
This fundamentalism is indeed pervasive. Here is another example: State policies that compress the income distribution - progressive taxes, safety nets, etc- clearly increase moral hazard and lead to less effort- the incentive to take actions that increase pre-tax income is dulled to some extent. That's enough to condemn such policies for the fundamentalists. But this is to ignore the huge benefits that such policies create by spreading risk more efficiently. Due to adverse selection, generalized income insurance is not a paying proposition for private insurers. Social welfare states, by making everyone join the pool, substitute for this missing market. There is a trade-off here, as in the LLR case, and it is a tradeoff not (or not just) between efficiency and equity, but between two sources of efficiency: lower moral hazard and more risk-spreading both increase "certainty-equivalent" income. Policies that increase income security are not wimply interferences with efficiency: they are part and parcel of what efficiency requires. The thorough-going "ownership society" - the end-point of moral hazard fundamentalism in this context,-by failing to see the trade-off involved, is an inefficent society, where certainty-equivalent income is lower than it could be. It's no different form the society that foregoes fire-houses due to the moral hazard of increased smoking in bed.
So the question becomes not only the trade-off between risk-sharing and moral hazard but also what kinds of risk-sharing should public policy underwrite and in what order of priority.
ReplyDeleteone trouble with this kind of thing is that while the arguments always sound plausible (to either side) when you are making them, they always depend upon ignoring the rest of the world... other causes and effects.
ReplyDeletefor example, social security reduces the incentive to work hard and save (it says here). but it may also increase the willingness to take the risks involved in changing jobs, or discourage "excessive" savings that might reduce sales and thereby discourage investment.
similarly, we always here that higher taxes reduce the incentives of the wealthy to work, and at the same time higher effective wages reduce the incentives of the poor to work. you see, it takes more money to incentivize the rich, but it takes less money to incentivize the poor.
and of course all of these things could be true, and there is no reason to give up talking about them, but once in a while i'd like to see the true believers in some Basic Law of Economics recognize that the world is a complex place.
A real "ownership society"--one without state-enforced privileges--would likely have far more compressed income distribution.
ReplyDeleteThe present income distribution reflects a hell of a lot of unearned income at the upper end: "intellectual property" [sic], professional licensing, rents on artificially scarce land and capital, oligopoly markups on the products of state-cartelized industry....
And guess what? It has HUGE incentive effects. Because labor does not internalize all the results of its effort, the capitalist corporation must resort to hierarchy, authoritarianism and extrinsic motivation to get effort out of people. As one of Ursula LeGuin's characters in The Dispossessed said of military chains of command, the hierarchy is the most rational way of getting people to do what they have no rational interest in doing.
A real ownership society, a free market economy of producer cooperatives, without privilege and artificial property rights like IP, would have a lot more incentive for ordinary people to produce because they'd be entitled to the product--and there'd be a lot fewer useless eaters at the top.
There is so much arm chair theorizing in this kind of conversation that anything siad could be true or not. These are subjective suppositions of the if then, then that stream of drivle.
ReplyDeleteSocial security is a disincentive to work? Any one satisfied with a social security monthly check to live on is a shmuck and could not possibly lend anything worth while to a productive economy. Social security was, and certainly is, only the means by which we avoid starvation and a card board shack in our old age.
High taxes could just as readily be argued to be an incentive to work yet harder, or to take greater financial risks as an investor. In fact, it's easier to steal from the general public than from the government so high taxes may have no effect. But if the IRS is going to take say 65% then he who wants the high life is going to have to work that much harder to pay for it. If those high marginal rates were a fact your investment loses would be shared to a hefty degree by the IRS. Remember, when taxes are high Uncle Sam is your partner in the loss column. With taxes being low for the too too rich, and with there being special treatment of capital gaines and inheritance, why does the wealthy individual ever feel the need to make any work effort at all.
Tax polilcy isn't for the purpose of creating incentives or disincentives. Taxes pay the cost of runninig the freekin country. Someone has got to take that responsibility. Again, I reiterate, it's not the taxation that is the problem. It's the way the revenue is spent. If we're going to piss away the Treasury in Iraq, or give special wealth transfer priviledges to the heairs of the vfery rich, or any such spending boondoggles, then we're going to have a taxation problem. No one wants to pay for some one else's largess.
The point I was making is simply that people who want a government that, through both its taxing and spending policies, creates a more equitable society (not the government we have now, of course, which does the reverse), needn't cede the efficiency question to the moral hazard fundamentalists. Dulling incentives ( a bad thing in and of itself) is sometimes the cost of providing a good thing, namely, more widely shared risk. My chair has no arms! (-;
ReplyDeletekevin,
ReplyDeleteI wasn't addressing your comment, just the general character of the over-all conversations that take place over these issues. Just the use of terms like "moral hazard" tends to obscure the point that the crux of the issue is no more complex than equitable distribution of the cost of government. Those who benefit most from the structure of our government and the economy that it supervizes, should bear the cost of that structure. Even a term like "shared risk," which in most usage would seem clear cut, becomes obscured when applied to complex economic concepts. Participation in such wonversations, wherein the definition of terms becomes vague and flexible, simply allows for the obfuscation of the real issues you want to uphold, like equitable distribution of the wealth that results from the efforts of all participants in an economic environment.
jack
ReplyDeletespeaking of obfuscation. wow!
we all want a more equitable distribution of income. and we all have a different idea of what that means.
hence, democracy. rule by the fooled.
probably better than rule by those who are sure of themselves, but certainly a fertile ground for airy theorizinig, and economists who take "incentives" too seriously.
It seems to me that an important question to consider is to what kind of incentives do people respond?
ReplyDeleteAs much as I enjoy playing with the idea of moral hazard arguments, I am not at all sure that such considerations are common place in decision making because of the "it won't happen to me" idea. I do it every time I get on my horse without my helmet; "it won't happen to me." And it isn't as though I ride more carefully without the helmet; actually, it is usually the opposite.
r.g.,
ReplyDeleteThat's a large part of my point, made above, that too much focus is put on hypothetical constructs that haven't been shown to be real in day to day decision making. The intuitive understanding of complex human behavior is little more than what is otherwise referred to as "common sense" when applied to the ideas of the average individual. When the quasi-scientist develops a hypothetical concept via intuitive understanding of events common sense takes on a more respectable aura. It's still not objectively established truth. It's barely an objectively supported theory.
i would suspect that businesses, as such, act more like the "economic man" than men do in their ordinary lives.
ReplyDeletesimilarly, a committee of lawyers and accountants might make decisions in which moral hazard plays a bigger part than it does for you and me.
perhpas the problem with economists is they take the behavior of businessmen, as such, and apply it to the behavior of ordinary workers.
Coberly,
ReplyDeleteIf I understand you correctly, then collectives are more likely to behave carefully in situations of moral hazard than are individuals. Did I understand your point correctly?
If that is true, then why would we still not behave in a "fundamentalist" way with regard to moral hazard? It seems to me that the action would be irrelevant for these collectives and for individuals would serve as a greater incentive to not chance "moral hazards."
Does that make sense?