It seems that whenever I start thinking about or discussing economics, I soon start going on about moral hazard. I think it tremendously important, and too little talked about or understood.

A recent short post on the facilitation of nihilism’s incipient historical suicide by prosperity and high technology was no exception. It provoked a long exchange of comments on quite a different (albeit related) topic: latter day capitalism versus distributism. As usual, I mentioned moral hazard:

If the moral hazard created by perverse policies – not of this or that administration, but often deep in the guts of the law – were purged, my guess is that … the size of the average enterprise would drop precipitously. Why? If for no other reason, there would be far less incentive to get big so as to be able to take big risks. Eliminating moral hazard means allowing people to suffer in their own bodies the risks of their actions. When the cost of a bad decision about risk on the part of your enterprise redounds immediately to your own personal situation, you are a lot more careful, a lot more circumspect. You dare less, and you want to have really good information about and control over the projects you take on, so as to control your risk. So you are less ambitious. And that means you grow much more slowly, and that your growth (all other things held equal) is healthier.

Which would result in a less volatile economy, greater average wealth, greater overall wealth, greater average prudence, and any number of other pleasant and salutary things, in the process leading society toward a distributist economic order.

In his response, regular commenter Ita Scripta Est said in passing:

And yet capitalism never quite seems to operate this way. The costs are socialized while the profits somehow always remain private.

He is exactly correct, and precisely nails the problem with latter day capitalism – and every other sublunary social order, whatsoever.

Socialization of costs *is* the artificial introduction of structural moral hazard to the social order. It does not itself generate wicked behavior – agents do that – but because it reduces the immediate pain of wickedness, it masks nature’s negative feedback to foolishness, and so deranges the factors of the moral calculus people use to assess the relative goodness of their options from one moment of decision to the next. It introduces noise to the discourse always proceeding within and between us, about what it is proper to do. Our decisions then more often err, and so we suffer more than we might have, even given our Fallen and defective moral engines.

Now, there is a certain degree of ineliminable moral hazard that comes along with society as such, for society just is (among other things) a socialization of costs. E.g., people band together to share and spread the risk that any one of them will fall prey to attack. Even such basic banding together cannot possibly be done without creating an opportunity for free riding – without, that is, creating moral hazard. Whatever that absolute minimum of moral hazard created by socialization might be, it is systematic, and is not amenable to correction by formal policy, law, regulation, or custom.

But most of the moral hazards we face are unsystematic – which is to say, corrigible. They are generated by (ostensibly) well-meaning policies introduced to correct for some problem or other. Something must be done about problems, to be sure – at least such problems as we can possibly ameliorate. But there is no act we can take, however prudent, sagacious or virtuous in itself, that does not create some subsequent opportunity for sin and error, if only by allowing us to live another day and make another moral decision. Any policy that structurally obscures the pain that signals error must therefore generate a structural marginal increase in error, and in the pain it generates – not, perhaps, of the sort that the policy was designed to correct, but somewhere in the system.

There is conservation of fairness. The absolute maximum of fairness – of, that is to say, social beauty – possible in principle to a given set of people, their tools and the available resources cannot be increased.[1] The degree to which that maximum is approximated can however be increased or decreased by their acts – by this or that decision, corporate or individual; by laws and regulations, by customs and fashions, and so forth. E.g., a fashion of piercing or amputating genitals is bound to decrease social beauty at the margin; a fashion of eating pure healthy food and engaging in regular moderate exercise is bound to increase it. Put another way, human acts can increase or decrease noise in the social discourse; noise being the biological form of the friction that accompanies thermodynamic processes of all sorts, and that dissipates capacity to perform work so as to achieve specific beauties.

This is no more than to say that we can achieve our ends in many different ways, some of which are more costly than others. Where costs are masked – where we deceive each other about reality, intentionally or no – achievement is vitiated.

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[1] New tools, resources or people can of course increase that limit.