Socialization of Costs is Moral Hazard

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.

 

______________________________

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

41 thoughts on “Socialization of Costs is Moral Hazard

  1. Kristor:

    In your scenario, where everyone has to take on their own risks, the big organization still has the advantage, because it is the only one able to survive failure.

    • Well, yes and no. Big organizations would still have an advantage where bigness was advantageous. But often it isn’t. As having more “surface area” (as it were) than small outfits, big organizations are exposed to many more risks. They are much more vulnerable than they seem. You can take out an aircraft carrier with a single cruise missile. Remember when IBM strode the landscape like a juggernaut? Where is Sperry today? Where, for that matter, is Japan, or Rome?

      We need big organizations to do big things, like the Panama Canal, or wiring North America with optic fiber and internet switches. What we want to avoid is bigness where it doesn’t make sense. How to tell? Well, trial and error, usually. Go until it hurts, is the basic rule. So, stop preventing nature’s feedback of pain to error, and you’ll have lots of companies right-sizing themselves sooner and more accurately, and long before they become so big that their failures are massive catastrophes for millions.

  2. Economies of scale are of course quite real, but only up to a point. Economies of regulatory capture, above & below board political influence, legal teams, patent and trademark law raise that profit max as a function of size quite a bit. Regimes where as few costs were socialized as possible would almost certainly shrink the average size of businesses.

  3. Kristor, this is an absolute gem of an essay. I have long thought that the apparent, and mutually felt, distance between distributists and anarcho-capitalist was a mostly a mirage. Examining Catholic Social Teaching in light of perverse incentives (moral hazards) is, I think, a very promising line of thought.

    • Thanks, Nick.

      Small can be truly Beautiful for human beings only if they are so made as to prosper better – not just more, but better – under something like the distributist ideal. But if it is our nature to do well under that ideal, then likewise must we be made to enjoy it more than the alternatives, and so to desire it more. And so we do: everyone loves the Shire. It would seem then that human nature left to itself, and deranged as little as possible by artificial interruptions of any sort, would operate in us so that we naturally and organically established our relations with each other along distributist lines.

      If on the other hand distributism can be established only by main force, because so few people like it, then it would seem to be an artificial ideal that does not happen to be truly good, and cannot therefore last.

      You can’t fight the Tao and expect to prevail. From where I sit, the Logos of things prefers Small as Beautiful for such as us.

      • If you would only try to appreciate what distributism is and not resort to right-liberal slanders, then it would be apparent that the very idea of ‘establishing distributism by main force’ is absurd.

        where, indeed, you got this idea that distributism is to be established by main force? name one distributist writer that recommends so?

        Your formulation is similar to those that cry Theocracy, theocracy whenever Church dares to raise its voice in the public square.

        Distributism is the idea that wealth distribution in a community is and ought to be a political matter and can not be left to chance, as libertarian and right-liberal theory recommends.

        This conforms to Church teaching on these matters and also some right-liberals themselves, such as Hayek with his notion of “several property”. The social good of private property is optimally realized when private property is dispersed.

        Now you may indeed argue that actual existing dispersion of property is not bad and we have no need for special policies. Or the pervasive separation of capital and labor is not a social evil. That would be actual arguments. But to endlessly raise bogey of forcible establishment of distributism is not it.

      • If you would only try to read and understand what I have actually written and not resort to knee jerk accusations based on fantastic misprisions, then it would be apparent to you that I never suggested that distributism would need to be established by main force. That conditional was offered as a *counterfactual.* It’s a common rhetorical device. *If* it were true that distributism could only be established by main force, then we might be able to conclude that it is unnatural or whatever. But, *of course,* *obviously,* it is *not the case* that distributism can only be established by main force. After all, as I said in the very comment you so completely and grotesquely misconstrue, “everyone loves the Shire.”

        Honestly, Vishmehr! Read what’s in front of you, not some bogey man you are projecting on your own inner screen.

      • I know the counterfactual. But why was it offered in the first place?
        there are distributist writers, past and present, and what have they proposed that leads you to immediately propose this counterfactual and none other?

      • I know the counterfactual. But why was it offered in the first place?

        To make exactly the sort of point that should appeal to you! I’m making your argument! How is this unclear to you? Why can’t you take “yes” for an answer?

        Wait a minute. No one can be that obtuse. You’re trolling me, right?

      • If “wealth distribution within a community” is “a political matter and can not be left to chance”, then how might distributism possibly be established except by force?

        If one were, perhaps, willing to leave wealth distribution “to chance”, it is arguable, I think Kristor is arguing, and I think many anarcho-capitalists would argue that you stand a better “chance” of having a more equitable distribution of wealth within a community if you minimize the socializing of costs, which by its very nature create perverse incentives. Tho’ it is impossible to UN-socialize all costs (the free rider problem is inherent to society itself), it is a clear moral good for the sovreign to try to minimize them. It is not at all clear that a sovereign is morally justified in placing absolute limits on the amount of wealth a person may acquire (without it being, for example, confiscated) or implement draconian measures to prevent him disposing of his property for not immoral ends. And even if it were morally justifiable, it is of dubious prudence.

      • Nick, I think Bonald suggested somewhere if state confiscated wealthy man’s property he should offer something instead – higher social status like joining aristocracy, hereditary title, public office or something like that. I don’t remember details of this proposal but at least it sounds more like justice.

      • Nick,
        Political action does not mean Red Army on march. Reform of fiat money and financial anonymous capital might well suffice.
        Let me remind people that Austrians demand reform of fiat money as well.

      • I would have thought the establishment of fiat money to be more an act of force against landed interests than the removal of it. Either way, I don’t see how either action can “implement” a “more equitable distribution of wealth”.

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  5. To continue a previous discussion here if i may.
    That nature is grounded in supernature and all things lead to God does not imply, by any means, that all behavior must have a biological or heredity component. It needs to be shown in each case. Let me remind you that the biological basis of homosexual behavior is still being debated.

    It may be truly so that homosexuality is not biologically caused but owes to lack of requisite male affirmation in certain periods. This theory has been discussed by Anthony Esolen at Touchstone website.

    More generally, we need to recognize and appreciate the reality of secondary causes (as opposed to the first causes). Otherwise, all sciences collapse unto theology. There is no need to take immediate recourse to theology. As Maritain discusses in Introduction to Metaphysics, there are two opposing errors, one, there are no relation between various disciplines, second, all disciplines collapse unto one–physics for materialists, and theology for you.

    • That nature is grounded in supernature and all things lead to God does not imply, by any means, that all behavior must have a biological or heredity component.

      I never said or implied that it did. Nor, more importantly, do I think that it does. So I’m not sure what you are responding to here. It isn’t me, or anything I’ve written.

      More generally, we need to recognize and appreciate the reality of secondary causes (as opposed to first causes).

      That all their causal powers are graciously provided to creatures by God does not at all entail that there is no such thing as creaturely causation. I never said or implied that it did. More importantly, I don’t think that it does. Voluntarism is as counterfactual as determinism. Again, you seem to be tilting at quintains that are not really there.

      It’s odd Vishmehr, truly. In the first paragraph of your comment, you scold me for my nonexistent suggestion that all behavior must have a biological or hereditary component. In the third, you scold me for my nonexistent suggestion that there are no causal components to things other than God. You can’t rightly criticize me for either one, of course, for I have advocated neither of those propositions. Neither of these particular critiques of yours are apposite to reality. But you might at least have been coherent if you had chosen between them.

      • This was apropos of the discussion of the biological underpinning, if any, of nihilism.
        My point is that any such thing needs to be shown and not assumed. And esp not assumed on the basis that nature is grounded in supernature and everything leads back to God.

        Problem is your immediate leaping back to theological explanations and underpinnings. Even the definition of ‘economic rationality’ you provided, no economist would recognize. It may be good mystically, but intellectually, it is not useful. Thus, the secondary causes need to be respected and discussed on their own terms. And this you are consistently failing to do, in my opinion.

      • I know what your comment was about. It would be more charitable to readers to post comments in the threads to which they pertain.

        … any such thing needs to be shown and not assumed

        OK. Turnabout’s fair play: can you show that, please, rather than just asserting it? Please do the same with all your other assertions …

        Oh, and this: which thing? Please take more time to compose your comments so that it is clear what they respond to.

        I referred to my posts about supernatural explanations only to destroy your assertion that I think like Dawkins. I suppose that tactic has now succeeded. It seems that it has; for now, rather than accusing me of his sort of crass materialistic reductionism, you are accusing me, equally baselessly, of crass spiritualistic reductionism.

      • thinking like Dawkins means to assume heredity underpinnings for any behavior. Your post about nihilists deleting themselves of the population was exactly so.
        There is no reason to assume that nihilism would be so deleted. If nihilism is a spiritual or cultural sickness, it could well spread even if individual nihilists were removing themselves from population.
        Not to mention, on heredity basis, the ancestors of nihilists should have been at least somewhat nihilists as well.

      • Thinking like Dawkins means to assume hereditary underpinnings for any behavior.

        *Any* behavior? Under your definition of thinking like Dawkins, anyone who thought that, e.g., our walking bipedally had some genetic underpinnings would be an atheist materialist, like Dawkins. That makes it too broad to be accurate, or useful.

        Your post about nihilists deleting themselves of the population was exactly so.

        No. You’re just wrong about this. I didn’t mention genetics or heredity in the post at all. Nor is it crass materialist reductionism to think that spiritual things can have an influence on worldly things, or vice versa. Indeed, to think that there might be such influences, as I do, is *exactly the opposite* of the crass materialism of such as Dawkins – or of crass idealism, for that matter.

        You are of course quite correct that nihilism could spread even if all the nihilists killed themselves this evening. The universe is a weird place; and demons are I feel sure playing an important role in the spread of nihilism. But what cannot be denied is that if the nihilists did all destroy themselves, they would thereby totally foreclose any possible direct influence they themselves could thenceforth exert upon other minds. Their personal additions to history would cease at that moment. And such an event could not but weaken, severely, the overall influence of nihilist ideas on the human beings who remained.

        Spiritual acts have historical effects, and historical facts influence spiritual acts.

        You prove this every time you decide to move, and your body – along with the *entire cosmos,* in a truly spooky feat of universal coordination – responds in immaculate accord with your decision. You prove it every time you make a decision based on what has just happened.

  6. Kristor,
    In Metaphysics of ownership, you quote Zippy:
    “Property exists when an owner exercises fungible authority over subjects with respect to one or more objects”

    This definition is circular since an “owner” is nowise defined. All it says that
    ownership exists when an owner does.

    • Property exists when a person exercises fungible authority over subjects with respect to one or more objects. Such persons are called “owners.”

      That should take care of it.

      • it begins to take care of it. The question that theory should answer is why and how a person gets to exercise this authority. This Zippy resolutely refuses to answer.

      • No; no one asks him that question, and he is not interested to answer it in the first place, being concerned with other matters. So no refusal has taken place.

      • vishmehr24:

        The question that theory should answer is why and how a person gets to exercise this authority. This Zippy resolutely refuses to answer.

        Authority doesn’t arise from having a theory of authority. A father’s authority, for example, exists independent of whatever theories various eggheads postulate to talk about paternal authority.

        Whether someone should have a theory that satisfies Vishmehr24 depends, I suppose, on what the universe owes Vishmehr24.

      • Vishmehr24:

        Is it still your position that Jews of Warsaw Ghetto are morally obliged to obey Nazi authorities?

        You must have me confused with someone else. I don’t believe I have opined on that subject.

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  10. 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.

    While this post provides a compelling and well crafted argument, I still find your underlying thesis problematic with particular reference to the quote above. This argument strikes me as the kind of ethic characteristic of 19th century social darwinism, an ethic that is still quite popular among radical libertarians who have (lamentably) come to wield a disproportionate amount of influence in traditionalist circles these days. I don’t mean to be crass or melodramatic in throwing around the admittedly loaded term “social darwinism” but I think this post warrants it for the sake of argument.

    This idea of nature’s “negative feedback” only really makes sense if we assume liberal metaphysics and anthropology i.e. man is not a social animal, but rather an rational supposedly self-reliant individual, who acts mostly out of pure self-interest on a self-regulating market, a market that just sort of appeared in mists of time. Now I realize few liberals actually take the matter to that extreme, after all the “commonwealth” should “socialize” the “costs” of providing a legal and adjudicatory framework for the enforcement of contracts, but its a fair assessment of liberalism’s core principles.

    But if one follows the traditionalist understanding man is by nature a social animal ultimately destined for eternal beatitude in a heavenly Jerusalem (a city not merely as individuals). The traditionalist does not ascribe to the liberal’s understanding of a mechanistic universe, thus “intervention” into the market is not self-defeating and is often times a moral duty of authority.

    Now take the recent financial crisis. In the previous post I complained about the banker bailout as a prime example of capitalism socializing the costs of its own failure. I neglected, however, to touch on the flip side of the meltdown. The Federal government allowed Lehmann Brothers a large and prestigious firm to collapse, thus setting off the “push” that brought the whole house of cards down. One could argue that the management and stockholders at Lehmann “learned their lesson.” But their collapse reverberated around the world, touched the lives of tens millions in an adverse way and yet what real* consequences have they suffered? Most of them are still worth millions and live comfortable lives I on the other hand have my life basically destroyed by what the financial system they help create (and no I did not take any mortgages or run up credit card debt). At any rate other comments above have raised this point as well so I don’t think I am completely off base.

    TLDR- We need an economic ordo that serves the common good, socialism and capitalism can only do this imperfectly.

    • This idea of nature’s “negative feedback” only really makes sense if we assume liberal metaphysics and anthropology i.e. man is not a social animal, but rather an rational supposedly self-reliant individual, who acts mostly out of pure self-interest on a self-regulating market, a market that just sort of appeared in mists of time.

      Not so. “Nature’s negative feedback to foolishness” is just a way of saying “the operation of the moral law written into the fabric of nature, and of men’s hearts.” You could call it Karma, or rta, or the Logos, or the Tao; you could say, “it’s not nice to mess with Mother Nature.” These are all equivalent conceptions. The notion that nature has an inherent moral order is prior to any and every social form, and undergirds social form per se.

      Note that in your previous comment complaining about the Federal bail out of the big banks and in this one complaining about the Federal failure to bail out Lehman – which is it, by the way, that you think is right? – you are not complaining about the free enterprise system sought after by the libertarians, but about the state capitalism they abhor. I.e., you are not complaining about the market, but about the depravations thereof.

      What’s “TLDR”?

      • by the way, that you think is right?

        I wouldn’t have let it get* to that point if I were setting policy.

        you are not complaining about the free enterprise system sought after by the libertarians,

        No capitalism always relies on a certain level of “cronyism” but the free market would be an evil order even if it lived up to the theories of libertarians (which it never has). Libertarians also shamelessly defend “cronyism” when it suits them. Distributists and left-libertarians have done a good job pointing out the duplicity of libertarians shilling for corporations like Walmart and McDonalds and then on the other hand blaming everything on “cronyism” when things go bad. Defenders of the “free” market can’t have it both ways.

      • I wouldn’t have let it *get* to that point if I were setting policy.

        Nor would I; nor, a fortiori, would any libertarian. Let’s stipulate then that the policies which led to the Crash of 2008 were insane and evil so far as Ita Scripta Est, Kristor, and libertarians are concerned. But that wasn’t the question. The question was whether you think it evil to let big financial firms fail, or to bail them out. You can’t have it both ways. I think it better to let them fail, sooner rather than later. You?

        … the free market would be an evil order even if it lived up to the theories of libertarians …

        So uncoerced transactions between humans are *inherently evil*? That’s what you are saying, you know: that when you buy food for your baby, you and your grocer are doing *evil.* Do you really mean that?

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