Friday, August 17, 2007

They're Alive!

Like thousands of other faculty, I will open my Principles of Economics class this Fall with a review of some of the basic ideas that form the economist mindset. How timely that two of these are so much in the news. I wanted to point them out here.

First are the ideas of tradeoffs and opportunity costs. I hope you noticed that the World Health Organization finally joined the calls to reintroduce DDT in the fight against malaria. I wouldn't want to drink DDT, and I'm sure that in the 1960s and 1970s there were environmental problems with the way that DDT was being used. But there was a tradeoff, an opportunity cost, to the virtual elimination of DDT from our arsenal in fighting malaria --- namely, malaria lived on and people died. For more background the the W.H.O. story go to Africa Fighting Malaria.

Secondly, I don't pretend to be an expert in financial economics. But I have been really surprised how many times the popular press has included in their coverage of solutions to the subprime mortgage credit problem an explicit discussion of what economists refer to as "moral hazard." Moral hazard is one of those unintended consequences concepts in economics, and it is simple: if "X" makes a mistake, and "X" gets bailed out by someone else, then "X" (or other "Xs") are likely to be even less cautious in the future. In this case, we're talking about the people who run or invest in complicated financial securities that have been hit hard. It interesting that it is so clearly recognized that some approaches to solving this problem create moral hazard, that is, make it more likely that we will have to bail someone else out in the future. Moral hazard is not a disqualifying condition, it simply needs to be taken into account. And, it's not just Wall Street high fliers that are a problem. It's a problem for issues of "Jubilee" style debt forgiveness for developing countries. It can even be present in individual acts of compassion. To repeat, the existence of moral hazard doesn't say don't do these things, but the person giving the aid needs to go in with full knowledge of the possible consequences.

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