Among economists and lawyers, the moral hazard problem or MHP has become a textbook illustration of what the late great philosopher of science and language Thomas S. Kuhn once referred to (somewhat enigmatically) as a disciplinary matrix, exemplar, or paradigm, i.e. a concrete “puzzle-solution” employed as a prototypical model or archetypal example by most members of an entire discipline or field. (See, e.g., Kuhn, The Structure of Scientific Revolutions, p. 11.) But what exactly is a “moral hazard”?

For its part, Wikipedia defines this term as “a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk.” Alas, this standard definition begs three key questions: (1) what are “costs” and “risks”?; (2) what are the reasons why an agent may want to avoid internalizing the costs of such risks?; and (3) which of those reasons, if any, are morally justified? Enter my colleagues David Rowell and Luke B. Connelly, who wrote a history of the term moral hazard (see also here for an ungated version). Below is a summary of their work:

This article traces the origins of the term “moral hazard” by going back in time to consider the earliest known developments of insurance as well as touching on a range of literatures as diverse as the theological and probability literatures and, latterly, the economics literature. Not surprisingly, we find that the concept of moral hazard developed with insurance markets. More importantly, we also show that the use of the term in the early insurance industry literature was ambiguous and, viewed from the vantage point of the modern economist, was used to describe not only moral hazard—as that term is understood by economists—but also the distinct phenomenon of adverse selection.

However the term is defined, aren’t government bailouts a classic example of the moral hazard problem? Also, what other examples of MHP, if any, keep you awake at night?