Sunday, October 9, 2011

Facing up to Moral Hazard

Systems upholding the law and standards help navigate the grey areas of moral hazard and adverse selection

Shyam Ponappa / October 6, 2011

Amid the general sense of an ailing socio-economic environment in the country, consider these situations:

  • Coal supplies for power generation are eight per cent short of generation capacity. Worse, nearly 42,000 Mw of additional generation capacity over the next five years is jeopardised because anticipated supplies are short by two-thirds of the requirement (100 million tonnes against demand for 313 million tonnes).
  • The rural employment guarantee scheme, well intentioned and with some reported successes (as in Melghat in Vidarbha), shows few tangible results while distorting farm labour practices and pricing. The reasons are many: inadequate design and supervision (mud roads that are washed away every year), no integration with agricultural programmes, palliatives that deny real infrastructure and support, like extension schemes that build on successes leveraging ICT, no skill development for alternative (self) employment, and so on.
  • The telecommunications sector is buffeted by scandal, the downward spiral of public sector operators BSNL and MTNL, and pressures of intense competition with constrained resources and regulations.

Leaving aside venality, a common thread is of laws and rules not upheld, slack standards, contracts not honoured, an absence of hard decisions and the requisite effort, and a degradation of mindsets. These are the grey areas of “moral hazard” on the one hand – where protection from the consequences of irresponsible actions induces irresponsibility – and of adverse or negative selection on the other, avoiding the best feasible choices for easier, inferior alternatives. They are widespread, and need assiduous effort to identify and set right with systems, even as criminality is dealt with by the legal system. Good people do not game situations for self-gain, but everyone faces the hazard in making choices. The importance of devising and upholding credible systems, standard operating procedures and laws that are seen to work through incentives and penalties is that these perceptions uphold the social contract and protect one from moral hazard.

Whatever the policies, they must have integrity and coherence; the hazard arises from not ensuring these conditions. The specific hazard is the change in behaviour for the worse. Absent this skein of expectations and constraints, there is no coherence to every individual’s uncoordinated wish list or gripes. This is the problem with well-intentioned social vigilantism, because it destroys the very fabric of order.


The hazards in grey areas are manifested in several ways.

(i) Abdication of responsibility by the government: The most prominent moral hazard may be the central government’s abdication of responsibility epitomised by the 2G scandal. A redeeming feature is that some alleged perpetrators are being prosecuted eventually — although how matters end will establish whether it is truly a redemption or a perpetuation of banditry with the state’s complicity (by abstaining from intervention). Similar scandals in mining and civil aviation are unravelling or are on the brink. It is these egregious developments added to the hassles in routine dealings with the government that have led to such public alienation.

There are also many errors of government omission or inaction, such as initiatives not taken in infrastructure, like stalled efforts at power supply reforms, including the state governments’ reluctance to address sustainable electricity tariffs, or not reducing the extent of administered pricing and taxes in petroleum products (or state governments imposing non-uniform sales tax), the deterioration in the railways, and so on.

(ii) Taking to the streets: Citizens who feel alienated can take to the streets when they are desperate or outraged. This seems to be the sentiment not only in the Arab spring, but also in varying degrees in established democracies in Europe, Israel and India. There are incipient signs even in America, with the amorphous “Occupy Wall Street” movement spreading from New York to other cities, protesting against various inequities.

When both government and citizens are irresponsible, chaos follows. In India, absence of governance is an extenuating circumstance for activism. But equally, there are indefensible lapses by citizens: the unwillingness to be disciplined, to outgrow the anti-colonial paradigm of railing against the government-as-imperial-ruler, of fasting and civil disobedience as acceptable forms of protest, of not subscribing to order, whether in traffic, respecting queues, or managing garbage and sanitation. Yet, reports of queuing by Delhi Metro users suggest that we can perform if we must — as do all the IT professionals delivering services to international markets. But for the most part, we rail against other people’s transgressions, while being unwilling to observe discipline ourselves.

(iii) Corporate chicanery: Apart from criminality such as in the mining and 2G scams, there is the grey area of bending the rules. Examples include the financial and operational performance of many real estate developers, or the poor automotive service quality that is an adjunct to the undeniably more refined automobiles themselves.

(iv) Media overreach: The advent of 24x7 news channels is a boon for choice and sourcing. Tragically, many have morphed into whipping up a frenzy rather than delivering solid news and balanced views, given the battle for viewership with a lowest-common-denominator bias for sensationalism.

(v) Stalled government decisions: Government decisions in a number of areas were already stalled owing to problems in the approach to land acquisition, environmental effects, and in sectors such as nuclear energy. A combination of circumstances comprising all these and hyper-aggressive audits, a popular outcry stoked by frenzied media treatment relating to scams in land acquisition, 2G spectrum, and mines, has in effect created a gridlock, in which no forward-looking decisions seem possible, because of the risk of retribution for perceived missteps or errors of judgment, with hindsight.

The grey areas occupy the space between what we want – superior standards – and what we have, which is a slackness of systems because of widespread shoddiness in the practice of leadership and citizenship, with neither inspiring confidence in the other. The way out is conceptually simple, though difficult to execute: take responsibility, devise coherent systems and practices in all areas, with incentives and penalties applied impartially, and live by them.

shyamponappa at gmail dot com


Posted by: Harish Kumar
I fully agree that the way out is conceptually simple, though difficult to execute: take responsibility, devise coherent systems and practices in all areas, with incentives and penalties applied impartially, and live by them.But here in India is there a political will to do so, also is every Indian ready take on the responsibility and share Government's policies in real spirit. Both seem to be invisible in nature.