The Case of Moral Hazard

Mainstream Economics and
Social Transformation:
The Case of Moral Hazard
John Latsis, Universities of Reading and Oxford
Constantinos Repapis, University of Oxford
Structure of the argument
i. The role of models in social transformation
 A gap in the economic ontology literature
ii. The role of models in modern mainstream
iii. Models as representations vs. models as
 Three epistemic features of models
iv. The case of moral hazard
 One analytical finding, three policy interventions
What is an economic model?
 No widespread agreement: ”… models can be
understood as complex objects constructed
out of many resources that defy simple
description" (Morgan 2008: 1)
 Yet they define the discipline, the profession
and justify imperialism (Fine and Milonakis
 How do we explain this tension between
centrality and ambiguity of models?
Functions of economic models
 Literature says that models are deductive &
mathematical in structure (Lawson, 1997, 2003)
 However, not all maths is an economic model, so
we distinguish them by functional role (Morgan
Fitting theories to the world
As instruments of investigation
Representing and intervening
"A 'theory' is not a collection of assertions about
the behaviour of the actual economy but rather
an explicit set of instructions for building a
parallel or analogue system - a mechanical,
imitation economy. A 'good' model, from this
point of view, will not be exactly more 'real' than
a poor one, but will provide better imitations."
(Lucas 1980: 697)
 Traditional debates focus on the limitations of
models as representations
 The link to reality is broken, but this does not
mean that models are irrelevant: they affect
actual social processes
 We can therefore see models as interventions
in the social world
• As they distance themselves from their
representative role models have become more
detachable from theory and malleable to
• Noticed in HET and Econ Soc, but not
approached in a theoretical manner
• Our emphasis is on 3 epistemic features of
models: specificity, portability, formal
Defining moral hazard
 In economic terms, moral hazard is seen as a
problem of incentives between a principal and an
 Concept borrowed from insurance
 Moral hazard vs. morale hazard
 “… the increase in probability of loss associated which
results from evil tendencies in the character of the
insured person…”
 ”…results from the insured person's careless attitude
towards the occurrence of losses."(Rowell & Connelly
Applying moral hazard 1
 Workers’ compensation schemes (Dembe and
Boden 2000)
 Injuries seen as part of a strategic game between
employees (agents) and employers (principals)
 Reduces worker environment to specific incentive
 Excludes complex relations between agents and
environment (social and psychological)
 Leads to one-sided policy interventions
Applying moral hazard 2
 The 2008 banking crisis (Dow 2010)
 The belief that commercial banks are too big
to fail led bankers to increase risk and
overextend lending, believing that national
governments will have to bail them out
 Reduces relations between client, bank and CB
into an incentive problem
 Denies the role of trust in underpinning the
banking system
Applying moral hazard 3
 Models of moral hazard in a monetary union
(Persson & Tabellini 1996)
 The model assumes that actual institutional
arrangements can be reduced to the incentive
structures they create for the relevant agents
in a moral hazard setting
 Extended to policy advice in Eurozone
sovereign debt crisis (Muellbauer 2012)
 Does the use of MH in these instances display the
3 features discussed earlier?
 MH was detached from insurance literature and
transformed into a incentives problem of
determinate form, displaying specificity
 The combination of the 3 studies show clearly
that it is a remarkably portable concept
 In all three cases the formal precision of the
economic approach to MH has crowded out
competing explanations from other social science