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“Moral hazard is a term that dates back to the 1600s. Until recent times its use has been mostly confined to the insurance industry to refer to behaviour that responds to changes in perceived risk.
The industry has noticed that people who have contents insurance are less careful about locking up. It has also noticed that drivers of cars with ABS brakes (superior brakes) did not have fewer accidents they had different accidents accidents consistent with high-performance cars, which is what they had become.
Why moral hazard? Clearly the insurance industry was disconcerted by behaviour that upset the calculations of its actuaries. Such behaviour had to be wrong immoral. But such behaviour is universal. Risk management is an exercise that involves striking a balance between the potential rewards and losses of decisions made in the face of uncertainty. A less judgmental term to describe this phenomenon is risk compensation. Legislators and regulators routinely ignore it.
Britain is suffering simultaneously from under-regulation and over-regulation. The deregulation of the financial markets under Margaret Thatcher gave a relatively small number of bankers free rein to contrive incentive structures that paid them fabulous rewards for taking risks with other peoples money. Meanwhile other spheres of activity are being suffocated by an excess of regulation, the most egregious example being the Independent Safeguarding Authority. This new bureaucracy, created as a response to the murder of two young girls in Soham, is charged with vetting an estimated 11.3 million people before they will be permitted to work, or volunteer with, children or vulnerable adults. The vetting involves a Criminal Records Bureau check on all 11.3 million after which we will decide on a case-by-case basis whether each person is suited to this work.
Leaving aside the mind-boggling expense and bureaucracy required to perform this feat, its effect is almost certain to be perverse. A CRB check will be seen as an insurance policy; behaviour that might previously have aroused suspicion is now less likely to be questioned because some superior authority has certified the suspect as safe.
After the Thatcherite deregulation, under New Labour we have had the Better Regulation Commission, the Better Regulation Executive, the Better Regulation Advisory Council and now BERR the Department for Business, Enterprise and Regulatory Reform. All these attempts at reform have explicitly acknowledged the damage caused by excessive regulation and have been powerless to resist it. Fundamental to this failure is a blindness to risk compensation.
Every perceptible safety measure that does not make the people want to be safer will provoke offsetting behaviour. The effect can be seen wherever one looks from protective equipment on the sports field, to the settlement of flood plains protected by higher levees, to bailed out banks. It can be found on the road and in the bed condoms are seat belts for sex concludes one study that invokes risk compensation to explain the failure of both safety measures to deliver the protection they promised.
Which takes me to my final point. The College of Emergency Medicine is leading a campaign to make cycle helmets compulsory. If successful it will result in a significant decline in cycling with a loss of attendant social, environmental and health benefits with no life saving benefit. It will kill off Londons new cycle hire scheme. In support of their campaign they cite the success of the seat belt law. But the law has failed and should be repealed. The Parliamentary Advisory Council of Transport Safety resolutely refuses to acknowledge evidence of this failure (click here, here and here). In its blindness to risk compensation and its consequences it risks helping to create a new, genuine, moral hazard.
PS The Manifesto Club campaigns against the hyperregulation of everyday life. It has a refreshing website – http://www.manifestoclub.com/.