Friday, December 4, 2009

Uwe Reinhardt on moral hazard and war

From Paying for Health Care (and War, by the Way) by Uwe Reinhardt:
"Moral hazard" is a term commonly applied to certain financial contracts, under which one party is obliged to pay another money if a specified event (e.g., illness or a fire or an accident) occurs. The term refers to situations in which the very existence of the contract alters the behavior of one party, so that it increases the probability of the event's occurrence or the size of the monetary payoff based on that event, or both.

In the context of health care, having an insurance plan will increase the likelihood that a person will actually use the health care system. It will also probably increase the resource-intensity of the treatments chosen by patients and physicians. Some economists even theorize that such coverage encourages unhealthy lifestyles and reckless behavior.

In the context of the wider financial sector, the now openly demonstrated willingness of our government—whether it be the Bush or the Obama administration—to make taxpayers bear the financial risk of serious mismanagement or risk within the private financial sector is likely to bring about the moral hazard of future mismanagement. Much has been written about that threat.

My point in the op-ed article was that the term "moral hazard" can also be applied to the contingency of war and its cost.

If the monetary and the blood cost of war are shifted mainly to citizens other than the elites who are empowered to declare war and decide how it is conducted, I argued, then that elite is more likely to embrace war and to spend on it.

The best definition I've heard for "moral hazaard" is "overconsumption due to artificially low prices". Most people in our society, myself included, pay an artificially low price for war, so we consume more than we would at equilibrium.

In my health econ class, we've looked a lot at moral hazard as it relates to insurance. It's interesting to note the more general applciation.

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