By The Rhetoric Collective in Society — May 27, 2023

Moral Hazard

Are morals hazardous?

Moral hazard is the concept that reveals the unintended consequences of protection and safety nets. This happens when an individual or organisation alters their behaviour due to reduced personal risk, often leading to risky actions or poor decision-making. Understanding moral hazard is crucial as it sheds light on the pitfalls of providing safety nets without proper accountability.

This arises when people or entities are shielded from the negative consequences of their actions. When individuals or corporations know that they will be rescued or protected from harm, they may take on more risk than they otherwise would have. This is because they feel a false sense of security which leads to a disregard for potential negative outcomes.

Examples of Moral Hazard:

1) Insurance: When an individual has insurance coverage, they might behave more recklessly, assuming that any losses or damages will be covered. For instance, a person with comprehensive car insurance might drive more aggressively, knowing that the insurance company will bear the cost of any accidents.

When individuals and organisations are shielded from the consequences of their actions, they may underestimate the true risk involved. This can lead to misallocation of resources and even harm to the particular stakeholder. This is known as distorted risk assessment.

2) Financial Sector: Moral hazard occurs when institutions or individuals believe that they will be bailed out by the government in times of crisis. This perception may incentivize them to excessive risk-taking, as they are less concerned about the consequences of their actions.

This behaviour can contribute to financial instability and erode market discipline, creating a "too big to fail" problem, where institutions take on excessive risk due to the expectation of a government rescue. See: Bank Bailouts: The Controversial Solution to Financial Crises

To mitigate moral hazard, it is crucial to implement well-designed incentive structures that align interest, promote accountability, and discourage excessive risk-taking. This can be achieved when governments enforce accountability for irresponsible actions by companies and individuals through prudent regulation and oversight.