Moral Hazard in the Scriptures

May 23, 2008 | 16 comments
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For those hoping to find more economics in their scripture study…

Moral hazard refers to people behaving differently (and typically worse) when they are insulated from the consequences of their decisions. It became a big deal in economics some 30 years ago as a problem with making contracts with incomplete information– a set of problems called “principal-agent” problems that can cause markets to fail. Now it is part of the core of any decent economics program and it is, I think, pretty obvious how it can be an issue in the Church and the Gospel. See wikipedia if you want more.

In studying employment it comes up because hired workers are likely to shirk unless they are heavily monitored, because they don’t get the profits. They are insulated from the results of their actions and this makes them work less. In development economics, this is tied to the problems with sharecropping, where the tenant lacks the incentive to work as hard because the landlord gets half of the profit. It is also proffered as a reason why family farms are more productive (per acre) than big farms in developing countries– family members may shirk less.

And from the book of John we have:

12 But he that is an hireling, and not the shepherd, whose own the sheep are not, seeth the wolf coming, and leaveth the sheep, and fleeth: and the wolf catcheth them, and scattereth the sheep.
13 The hireling fleeth, because he is an hireling, and careth not for the sheep.

Classic example of moral hazard; stewards who are not internally motivated tend to do a bad job.

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16 Responses to Moral Hazard in the Scriptures

  1. John Buffington on May 23, 2008 at 12:13 pm

    Frank

    To further your desire to make gospel study more “dismal”, consider the following

    In political science and economics, the problem of motivating one party to act on behalf of another is known as ‘the principal-agent problem’. The principal-agent problem arises when a principal compensates an agent for performing certain acts that are useful to the principal and costly to the agent, and where there are elements of the performance that are costly to observe. This is the case to some extent for all contracts that are written in a world of information asymmetry, uncertainty and risk. Here, principals do not know enough about whether (or to what extent) a contract has been satisfied. The solution to this information problem — closely related to the moral hazard problem — is to ensure the provision of appropriate incentives so agents act in the way principals wish. In terms of game theory, it involves changing the rules of the game so that the self-interested rational choices of the agent coincide with what the principal desires.

    If we could eliminate the information asymmetry, this almost describes our relationship with God. He directs, and we act as agents to bring him glory. Like much of behavioural economics, maybe it could be argued that we act AS IF there is an asymmetry due to our mis-perception that sometimes He is not monitoring? Are blessings the equivalent of the economic incentives He provides in order to reduce monitoring cost?

    If this is the case, then this is an interesting definition of “agency” which would describe the relationship between man and God. I think it is infinitely more tractable to think of agency as “I can choose to enter into a principal-agent relationship with God” than the more typical notion of “I can do what I please”

    Maybe a bit strained, but it is a slow afternoon

  2. Frank McIntyre on May 23, 2008 at 12:17 pm

    “Like much of behavioural economics, maybe it could be argued that we act AS IF there is an asymmetry due to our mis-perception that sometimes He is not monitoring? ”

    Probably. Or we act AS IF he didn’t care or didn’t exist.

    “Are blessings the equivalent of the economic incentives He provides in order to reduce monitoring cost?”

    I think a lot of them are.

  3. Adam Greenwood on May 23, 2008 at 12:28 pm

    Balaam is a good example of an agent who was tempted to use the powers conferred on him by agency for his own gains rather than in the interests of his principal. Luckily his principal had effective monitoring and enforcement mechanisms.

  4. Adam Greenwood on May 23, 2008 at 12:32 pm

    Other scriptures that relate on the scriptures on priestcraft and the scriptures on unrighteous dominion.

    False priests are obviously different, but most of the condemnations of priestcraft would apply to legitimate priests who abuse their position. In the gospels, for example, the Jewish high priests are treated as legitimate in some sense but also as corrupt and wicked.

    The scriptures on unrighteous dominion are almost a classic description of the principle-agent problem.

  5. Robert C. on May 23, 2008 at 12:32 pm

    We had a seminar presenter yesterday make a related point: in terms of “public trust,” less legal regulation guaranteeing enforcement can lead, rather counter-intuitively, to more trust. The idea is that others only really gain our trust when we voluntarily act in a trustworthy way. I think this point has interesting analogies to lower vs. higher law types of issues in scripture, where “it is not meet that . . . [we should be] compelled in all things” (D&C 58:26), but do many things of our “own free will”. Thus, we might think that it is actually through the lack of law (i.e., the law points to Christ who is beyond the law) that we are able to develop into trustworthy stewards (I think this also has interesting implications for thinking about the fall and the veil as being necessary for our spiritual development…).

    Here’s the SSRN link to the paper (Bruce Carlin from UCLA was the presenter–he has several other papers that are closely related to this same result): “Public Trust, the Law, and Financial Investment”

  6. StillConfused on May 23, 2008 at 1:36 pm

    So are people who are more self governing more likely to be in an ownership position or does the ownership position make a person more self governing. Likewise, is a person less self governing because he is an employee or is he an employee because he is less self governing?

  7. Mark B. on May 23, 2008 at 2:05 pm

    Which all suggests that the employer-employee model is all wrong, from the standpoint of moral hazardists. The “employee” should, it appears, be a “partner” instead, sharing in the profits from the enterprise.

    But the sharecropper example doesn’t make sense. If the sharecropper receives one-half of the land’s produce, any one-unit increase in that production results in a half-unit increase in the sharecropper’s portion. Why wouldn’t he have the incentive to increase production as much as possible?

    Sure, it’s better if 100% of the production is available to the sharecropper, but the real disincentive to produce seems to hit at the wage-earner. It’s sort of like an associate at a big law firm. Why work the 90-hour week just for the chance of becoming a partner, if there’s no immediate change in current compensation? Why work so hard if (a) the odds of becoming a partner appear to be falling or (b) one discovers that life as a junior partner is just as miserable as life as a senior associate?

  8. Adam Greenwood on May 23, 2008 at 2:11 pm

    Partners have moral hazards too, Mark B. If we all share alike in the profits, my incentive is to skimp or cheat on my efforts.

  9. Frank McIntyre on May 23, 2008 at 2:17 pm

    Mark, the incentive problem is clearly worse for wage earners than sharecroppers. The law example is right on.

    But it isn’t hard to show that the sharecropper will also underproduce. He will equate the marginal cost of his time and effort to the marginal benefit he gets, which is less than the social benefit to him and the landlord combined– and so he stops working too soon. It’s basically like a positive externality problem, if that makes sense.

    “Which all suggests that the employer-employee model is all wrong, from the standpoint of moral hazardists. The “employee” should, it appears, be a “partner” instead, sharing in the profits from the enterprise.”

    This was basically Alfred Marshall’s point– sharecropping was a bad idea and should be replaced with tenants leasing the land at a fixed rate and getting all the profits. What he failed to account for is the risk the tenant now faces (which is considerable in unirrigated agriculture). In the 70s, models of risk were getting a lot better and so it was easy to show that sharecropping could be an optimal response to risk– even though it creates a moral hazard problem.

  10. Frank McIntyre on May 23, 2008 at 2:19 pm

    “Partners have moral hazards too, Mark B. If we all share alike in the profits, my incentive is to skimp or cheat on my efforts.”

    this too, Unless partners are easy to monitor and so one can enforce rules about work and effort. It’s like a group blog!

    “So are people who are more self governing more likely to be in an ownership position or does the ownership position make a person more self governing.”

    Probably both.

  11. Mark B. on May 23, 2008 at 2:38 pm

    The words make sense, and the terms marginal cost and marginal utility do too (I did have two quarters of Tort Law from Richard Posner, after all), but the overall concept is a ways off–and it’ll have to remain there as I try to get some work done this afternoon.

    Besides, I’m still working on my pet theory of “sprawling development as an externality (negative, of course) in light of rising fuel costs.” There’s only so much externality space available in my head, before I have to start externalizing other, more needful, things.

  12. Researcher on May 23, 2008 at 2:51 pm

    Whoops. Just tried to paste a link and it went into moderation. Here’s a restate so it doesn’t need to be posted.

    Back in the days when we lived in the upper Midwest, we would shop at Woodman’s Food Market. They were employee owned and their service and selection and prices were great.

    Employee-owned businesses would seem to deal with some of the weaknesses due to the principle of moral hazard.

  13. Matt Evans on May 23, 2008 at 3:56 pm

    Re: Employee-owned businesses

    This doesn’t solve the problem structurally if there are still information gaps. Imagine 100 employees own a store. If Employee #1 loafs and does no work while everyone else sweats, he still get’s 99% of his potential profit for 0% effort rather than 100% of his potential profit for 100% effort. And if he embezzled $100, he’d have $100 in his pocket but his profit from the store would only decrease $1.

    This is why even CEOs and other corporate officers steal from their companies (or, less obviously immoral, vote themselves sweetheart benefit packages, or expense fancy hotels and dinners to the company account) even though they have large equity interests.

  14. Peter LLC on May 23, 2008 at 7:23 pm

    In studying employment it comes up because hired workers are likely to shirk unless they are heavily monitored

    You are singing my employer’s tune. According to my contract, laziness is the number one reason for immediate dismissal. And anyone who thinks they cool their heels for a few months by getting pregnant can forget it–mommies to be get the axe too. A coma looks like a pretty good cover, however. The local labor regulations require that all employees be informed of their termination, which, given the current state of a certain employee (he is in a coma), is not possible. You should have heard the gnashing of teeth when the legal advisor told the boss he couldn’t be fired.

    Anyway, by a show of hands, who here blogs on The Man’s time?

  15. Thomas Parkin on May 23, 2008 at 9:58 pm

    “Employee-owned businesses would seem to deal with some of the weaknesses due to the principle of moral hazard. ”

    In 1998, I was the 40th employee at a company whose market cap grew to $4 billion. The officers of the company publicly stated that their aim was to turn their employees into millionaires – and we were well on our way to that before the Nasdaq crash. I don’t know that I became anything like hyper-dilligent, but the genuinely loyal attitude of the executives of the company towards thier employees, which was repeatedly demonstrated, created an incredible loyalty in those of us who came in early. Even now, ten years later, if they asked me to join a new enterprise, I would do so even at considerable personal cost.

    ~

  16. Raymond Takashi Swenson on May 25, 2008 at 10:00 am

    In the book Freakanomics, the authors discuss their research findings that most drug dealers make less money than people at McDonalds, and they only stay in the game in hopes of rising to the top of the pyramid, where the real profit is. Apparently it is the hope of reward rather than the reality of it that motivates them. And there is always a new crop of dupes to be recruited.

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