Moral Hazard

July 26, 2020

by Steve Stofka

This week additional unemployment benefits will cease but Senate Republicans and the White House announced that they could not agree among themselves about the appropriate course of action for a second stimulus bill. What is the problem? Many Republicans think that an extra $600 a week in unemployment benefits rewards people for not working. The issue is a familiar one to policymakers and economists: moral hazard.

Moral hazard arises when party A has no incentive to do X because party B will pay the cost. In this example, Party A = a taxpayer. X = go to work. Party B = the federal government. An insurance policy illustrates the problem of moral hazard. If an insurance company – called the principal – provided comprehensive insurance for a house, the homeowner – the agent – would have less incentive to maintain the property because the owner bears little of the cost of repair. Comprehensive is the key word. There must be some cost to the insured. Moral hazard was evident during the financial crisis over a decade ago. Financial traders made a lot of money by taking risks. When those risks blew up, taxpayers picked up the bill for the loss.

Another key ingredient of moral hazard is asymmetry of information. In a purchase transaction, the seller – the one receiving the money – knows more about the item being sold than the buyer – the one paying out the money. Laws and regulations attempt to minimize the asymmetry, but it is an inherent feature of a transaction. In a principal-agent model, the agent – a babysitter or the CEO of a public company – knows more than the principal – the parents or the stockholders. The principal must trust the agent to some degree and monitor the agent to some degree.

With that bit of background, let’s return to the issue of extended unemployment benefits. Who is the agent and who is the principal? Republican leaders think of themselves as the principal, as though it was their money that they are paying out. In their thinking, we, the taxpayers, are the agents who cannot be fully trusted. If Republicans pay people unemployment benefits, how do they know that people will look for a job?

This concern demonstrates the patriarchy that is the core ideology of the Republican Party. Lawmakers are not the parents, or the principals. In a democratic republic, lawmakers are the agents of the citizens. We worry about the moral character of our representatives, not the other way around. We, the citizens, are the principals.

Senator McConnell says that he is acting on behalf of taxpayers. Which taxpayers is he referring to? The ones who will be unable to pay their mortgage or their rent next month? The taxpayers of the future? He wasn’t concerned about them when Republicans passed their tax bill a few years ago. That tax bill was meant to appease the stakeholders, the big moneyed interests that are the real principals in this country. In effect, we, the citizens, are but their agents.

230 years ago, American colonialists rebelled against the aristocracy that controlled the economy and politics of Britain and its colonies. Here we are again. Senator McConnell is one of the most powerful men in this country because he is an agent for the American aristocracy. For one day a year, citizens act as principals by voting. Sensing that the tide of sentiment is going against Republicans in this election, Republican lawmakers and the White House are trying every legal maneuver to deny the vote to as many people as possible.

The moral hazard is when the agent takes effective control from the principal. That is the government of Venezuela under Nicolás Maduro. The Republican party proclaims that they are the champions of “small government.” What those two words mean is government by a small elite. If you prefer an impotent and passive role as a citizen, vote Republican this fall. If you want a more robust government which acts like an agent of the people, make another choice.

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Photo by Esteban Lopez on Unsplash

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