I’ve taken some time out recently to delve behind the news headlines concerning the financial Armageddon that apparently threatens life as we know it – double-dip recession, Eurozone crisis, contracting economies and the rest. Why? Because I can’t help feeling that there are major moral issues behind it all, and for me moral issues are religious issues.
Amidst the banker bashing and political propaganda surrounding all this, I have been surprised to hear learned economists referring to ‘moral hazard’ in relation to their sphere of activity. Are we suddenly becoming concerned about morality? I certainly think that would be a good thing – but is it real?
First it is necessary to understand what the term ‘moral hazard’ really means. It refers to the separation of actions from consequences. Once that has occurred, what incentive is there for people to act fairly? Most obviously, if a bank is ‘too big to fail’ – which is to say, it will always have to be rescued if in trouble – what incentive is there for its executives to avoid foolish risk? Or, if a country in the Eurozone is always to be ‘bailed out’, what incentive is there for its government or people to organise their finances responsibly? This latter point is particularly important, of course, to Germany, which seems destined to do much of the bailing.
I first remember hearing the term ‘moral hazard’ at the time of the Lehman Brothers collapse. The danger of moral hazard was one reason it was allowed to fail. However, once the ‘contagion’ (as we now call it) became apparent, the danger of moral hazard was trumped by the danger of global financial breakdown.
We do not learn from history. The concept of moral hazard goes back at least to the seventeenth-century ‘bubble’ that caused the Dutch tulip bulb crisis, probably the earliest example of such a speculative disaster. I suspect the idea goes back much further, in fact the Greeks (ancient, that is) probably had a word for it.
There are two surprising things about the ‘moral hazard’ concept. The first is that, once the idea gets around, we might realise that in fact there is moral hazard in many areas of life – wherever people are, perhaps, more aware of their rights than of their responsibilities.
The second surprise is that so few of the usual moral arbiters in our culture, particularly in the religious sphere, have had much to say on this subject. Even when comment is made, many of them are one sided, and do not seem terribly well informed. If religion cannot talk with some authority about this issue, tailor-made for sensible but passionate debate, what exactly can it talk about?
Try, instead, the concept: “perverse incentives.” ie when a system of economic activity actively rewards dishonesty and short-sighted irresponsibility, penalizes any attempt to make the system function in support of human good.
Bill Black on the neweconomicperspectives (org) site is good, from the perspective of a former investigator of corrupt institutions during the Savings & Loan crisis.
Likewise Michael Hudson on the history of economic thought & the background behind that phrase. (also some good stuff on economic arrangements in the ancient Near East.) michael-hudson.com (A common enough name to require a link to the right ‘Michael’.)
Mark Silversides said:
Thanks. I think one of the big questions is whether these perverse incentives arise inevitably in all economic systems of whatever type, or are they a particular affliction of western capitalism? Myself, I think the former.
Ian Birkin said:
I tend to agree that it is the former. Issues about power and control give the framework, I believe. Since people are intrinsically sinful then the systems put in place will be ultimately flawed too. However, we should still try to make them as good as they can be. Putting counterbalances in place is a strength of western capitalism; I don’t see evidence that totalitarian led economies lead to “purer” incentives. It’d be interesting to hear what others think.
Send Baggage to Austria said:
You really make it seem so easy with your presentation but I find this
topic to be actually something that I think I would never understand.
It seems too complex and very broad for me. I am looking forward for
your next post, I will try to get the hang
Mark Silversides said:
I generally get accused of making things complicated, so there’s a first! Seriously, though, I don’t think moral issues are easy. But I don’t see how we are to avoid them if chaos is unacceptable.
Mark Silversides said:
Is it individuals who are intrinsically sinful (which means they are bound to make flawed systems) or is it the flawed systems that are intrinsically sinful (so that they are bound to corrupt individuals?