Irrational Economist_ Making Decisions in a Dangerous World - Erwann Michel-Kerjan [98]
One possibility, of course, is that suggested by behavioral economics: The financiers were subject to cognitive biases. Because of the specialization induced by the nature of information as discussed in the last section, the transactions were large on the scale of the market and so had important consequences for the system as a whole.
However, there is an alternative view, suggested by many in the media and in academic circles, that, given the incentives, the agents were actually behaving rationally. The root of the matter is that liabilities are limited from below. A firm can go bankrupt, but that is the worst that can happen to it. Similarly, an executive of a company can at worst be dismissed (at least if he has not committed any fraudulent activity). The extra bonuses compensating him or her for performance in the event that things went well are not paid back in bad times. As a result, a risky investment that is socially unprofitable (a negative expected value or a positive expected value insufficient to compensate for the market-determined risk level) may be privately rational for the decision maker, because the latter will not bear all the negative consequences he or she imposed on others.5
This incentive problem is intrinsic to the nature of modern capitalism. It is built into the concept of limited liability. Obviously, one aim of this policy is to increase the ability to take risks. The only question is whether, in a world of imperfect and asymmetric information, it does not lead to excessive risk-bearing. These are problems that need to be addressed.
RECOMMENDED READING
Arrow, K. J. (1953). “Le role des valeurs boursières pour la repartition la meilleure des risques.” In Économetrie, Colloques Internationaux du Centre National de la Recherche Scientifique, Vol. 11, pp. 41-47.
Arrow, K. J. (1963). “Uncertainty and the Welfare Economics of Medical Care.” American Economic Review 53: 941-973.
Arrow, K. J. (1963-1964). “The Role of Securities in the Optimal Allocation of Risk Bearing.” Review of Economic Studies 31: 91-96. (English translation of Arrow [1953].)
Arrow, K. J., and G. Debreu (1954). “Existence of Equilibrium for a Competitive Economy.” Econometrica 22: 265-290.
Debreu, G. (1959). Theory of Value. New York: Wiley.
Friedman, M., and A. J. Schwartz. (1963). A Monetary History of the United States, 1867- 1960. Princeton, NJ: Princeton University Press.
Hicks, J. R. (1939). Value and Capital. Oxford: Clarendon Press.
Kane, E. J. (1989). “The High Cost of Incompletely Funding the FSLIC Shortage of Explicit Capital.” Journal of Economic Perspectives 3: 31-47.
Kurz, M. (1974). “The Kesten-Stigum Model and the Treatment of Uncertainty in Equilibrium Theory.” In M. Balch, D. McFadden, and S. Wu, eds. Essays on Behavior Under Uncertainty. Amsterdam: North Holland Publishing.
Kurz, M. (1996). “Rational Beliefs and Endogenous Uncertainty: An Introduction.” Economic Theory 8: 383-397.
Laffont, J.-J., and D. Martimort (2002). The Theory of Incentives. Princeton, NJ: Princeton University Press.
Mill, J. S. (1848). Principles of Political Economy, 7th ed. (1909). William J. Ashley, ed. London: Longmans, Green and Co.
Morgenstern, O. (1935). Vollkommene voraussicht und wirtschaftliches gleichgewicht. Zeitschrift für Nationalökonomie 6: 337-357.
Walras, L. (1874, 1877). Éléments d’économie politique pure. English translation by W. Jaffé (1954). Elements of Pure Economics. Homewood, IL: Irwin.
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Environmental Politics
Are You a Conservative?
GEOFFREY HEAL
Environmental conservation need not, and indeed should not, be a partisan political issue. Conservatives, after all, are in principle interested in conserving, and that is what conservation is about.1 Two of the best presidents from an environmental perspective were both Republicans—Teddy Roosevelt and Richard Nixon. The third of the top three environmental presidents was Lyndon Johnson. Yet environmental conservation