Wednesday, 28 April 2010

Markets and moral hazard

In the Marsden Jacobs report on the costs and benefits of alcohol (available here and here) Marsden Jacobs write, at paragraph 58:
They do not bear the full costs because friends, families, partners and governments act to offset these costs. A rational fully informed drinker would recognise and anticipate this support when making his consumption decisions. If the subsidy from the welfare system and/or from the support of other individuals were removed, the individual would make different choices. This is a form of moral hazard since drinkers (even if perfectly informed of the costs and risks) know that they will not bear the full costs. The individual drinker does not count the cost of these subsidies since they are a benefit to him, but they are a cost elsewhere.
In a reply to this argument at Offsetting Behaviour Eric Crampton writes,
Is there any consumption - cars, movies, anything at all - for which this would not be true? Do we say that the cost of McDonald's food is not internalized because people on welfare would buy less McDonald's food if they didn't get welfare payments? Do we reckon that Corvettes are horrible things because men in their late 40s buy them and impose those costs on their families? This is ludicrous.
and further writes,
On cost shifting to family and friends, I can't help but wonder whether their argument proves too much: all kinds of consumption decisions we make have effects on friends and family. I may spend too many late nights reading shonky alcohol policy reports and be grumbly the next day; if I had to bear all of the costs thereby imposed on my family, I might do less of that. But, of course, families have ways of internalising those effects: my wife rightly ensures as much.
Even if we accept the Marsden Jacobs argument that there is a moral hazard problem here we still have to ask what is the best way of dealing with it? We know from other examples of moral hazard that markets can, and do, deal with the problem better than the government does. Insurance companies, for example, deal with moral hazard via things like excesses or no claim bonuses. Most research shows that asymmetric information isn't a big problem for most markets. We can buy insurance or a good used car so the asymmetric information problems have to have been dealt with, at least, to a degree which allows the market to function. So why would government action be better in this alcohol related case?

As Eric notes Mrs C can internalise any costs that Eric imposes on his family from spending too many late nights reading shonky alcohol policy reports and being grumpy the next day and his friends at work can also take action to deal with the problem. What I don't see is how the government could do any better. Would a tax on alcohol reports really better than the actions of Mrs C and Eric's workmates?

The question that the Marsden Jacobs argument raises is that even if we accept the reasoning, is government action really the best way of dealing with the problem? Many would have doubts that it is.

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