Recently the Liberal Party suffered a landslide defeat in the state elections of Western Australia. While local issues dominated, Australian Prime Minister Malcolm Turnbull's falling popularity also contributed to the loss. Part of the difficulty afflicting Turnbull and damaging the Liberal brand is the popular perception that he lacks conservative political convictions. One potential solution to help him navigate his way through policy choices is the notion of moral hazard.
Originally moral hazard referred to the greater risks an insured person will take when the costs of carelessness are transferred to the provider. According to the Financial Times lexicon, "Moral hazard arises when a contract or financial arrangement creates incentives for the parties involved to behave against the interest of others."
We heard a lot about moral hazard with the taxpayer bailout of big U.S. banks after the 2008 financial crisis. Why would bank CEOs behave responsibly if the profits when the gamble pays off are kept by shareholders, but any losses are borne by taxpayers? When a fire destroys homes, similarly, some people might be caught out with homes that were uninsured. If the government compensates them for their losses, will this encourage others to drop their insurance policies and look to government bailouts as well?
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