Thursday, 3 July 2014

Moral hazard and climbing mountains in flip flops

The Lochaber Mountain Rescue team in Scotland recently had to rescue someone who fell after setting off up one of Scotland's highest mountains in flip-flops. This looks like a textbook example of moral hazard. Moral hazard arises whenever someone (the principal) 'employs' someone else (the agent) to do a job and the agent takes 'more risk' than the principal would like. In this case mountain rescue essentially 'employs' people to not be dumb in the mountains, but too many of us are dumb in the mountains.  
        But, here's an interesting issue: In the textbook story of moral hazard the agent takes proper account of incentives. So, a person takes greater risk in the mountains because he knows that mountain rescue will save him. On this account, scrapping mountain rescue might negate the need for mountain rescue. 
        I would be surprised, however, if the three men involved in this story knew a great deal about Lochaber Mountain Rescue. Instead, I would suggest they were responding to a more generalized moral hazard 'if something goes wrong someone will save me'. With this more generalized moral hazard people are going to risks whether mountain rescue exists or not. So, you better have a mountain rescue.
        It is easy to see how such generalized moral hazard can become too big a burden on society. If people expect that 'someone will save me' then we need a lot more than mountain rescue. It always amazes me, for example, when listening to radio phone-ins and the like, how strongly some people feel that they have a right to welfare payments and benefits. It is a kind of 'because I am poor someone must rescue me' type of argument.
        Let's be clear. I am not arguing that we should scrap mountain rescue or stop transferring wealth to the poor. What I am arguing is that there needs to be a greater recognition such things involve voluntary transfers. People are not rescued off mountains by pixies, they are rescued by people who voluntarily give of their time. Similarly the money for welfare payments does not grow on trees, it is a 'voluntary' transfer from rich to poor.
        If we forget the voluntary nature of transfers then generalized moral hazard will be impossible to keep in check. Basically, we get a strange reversal of roles. It is supposed to be that because of mountain rescue people take more risk in the mountains. Or, because of welfare people take more risk with investing in their future. But, we increasingly seem to live in a world where people take risk in the mountains because they expect there to be a mountain rescue. And they take risk investing for the future because they expect the welfare system to save them.             

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