The Case of Moral Hazard

Report
Mainstream Economics and
Social Transformation:
The Case of Moral Hazard
John Latsis, Universities of Reading and Oxford
Constantinos Repapis, University of Oxford
Structure of the argument
i. The role of models in social transformation
 A gap in the economic ontology literature
ii. The role of models in modern mainstream
economics
iii. Models as representations vs. models as
interventions
 Three epistemic features of models
iv. The case of moral hazard
 One analytical finding, three policy interventions
What is an economic model?
 No widespread agreement: ”… models can be
understood as complex objects constructed
out of many resources that defy simple
description" (Morgan 2008: 1)
 Yet they define the discipline, the profession
and justify imperialism (Fine and Milonakis
2009)
 How do we explain this tension between
centrality and ambiguity of models?
Functions of economic models
 Literature says that models are deductive &
mathematical in structure (Lawson, 1997, 2003)
 However, not all maths is an economic model, so
we distinguish them by functional role (Morgan
2008):



Fitting theories to the world
Theorising
As instruments of investigation
Representing and intervening
"A 'theory' is not a collection of assertions about
the behaviour of the actual economy but rather
an explicit set of instructions for building a
parallel or analogue system - a mechanical,
imitation economy. A 'good' model, from this
point of view, will not be exactly more 'real' than
a poor one, but will provide better imitations."
(Lucas 1980: 697)
Continued
 Traditional debates focus on the limitations of
models as representations
 The link to reality is broken, but this does not
mean that models are irrelevant: they affect
actual social processes
 We can therefore see models as interventions
in the social world
Interventions
• As they distance themselves from their
representative role models have become more
detachable from theory and malleable to
circumstance
• Noticed in HET and Econ Soc, but not
approached in a theoretical manner
• Our emphasis is on 3 epistemic features of
models: specificity, portability, formal
precision
Defining moral hazard
 In economic terms, moral hazard is seen as a
problem of incentives between a principal and an
agent
 Concept borrowed from insurance
 Moral hazard vs. morale hazard
 “… the increase in probability of loss associated which
results from evil tendencies in the character of the
insured person…”
 ”…results from the insured person's careless attitude
towards the occurrence of losses."(Rowell & Connelly
2012)
Applying moral hazard 1
 Workers’ compensation schemes (Dembe and
Boden 2000)
 Injuries seen as part of a strategic game between
employees (agents) and employers (principals)
 Reduces worker environment to specific incentive
problem
 Excludes complex relations between agents and
environment (social and psychological)
 Leads to one-sided policy interventions
Applying moral hazard 2
 The 2008 banking crisis (Dow 2010)
 The belief that commercial banks are too big
to fail led bankers to increase risk and
overextend lending, believing that national
governments will have to bail them out
 Reduces relations between client, bank and CB
into an incentive problem
 Denies the role of trust in underpinning the
banking system
Applying moral hazard 3
 Models of moral hazard in a monetary union
(Persson & Tabellini 1996)
 The model assumes that actual institutional
arrangements can be reduced to the incentive
structures they create for the relevant agents
in a moral hazard setting
 Extended to policy advice in Eurozone
sovereign debt crisis (Muellbauer 2012)
Conclusions
 Does the use of MH in these instances display the
3 features discussed earlier?
 MH was detached from insurance literature and
transformed into a incentives problem of
determinate form, displaying specificity
 The combination of the 3 studies show clearly
that it is a remarkably portable concept
 In all three cases the formal precision of the
economic approach to MH has crowded out
competing explanations from other social science
perspectives

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