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Terrorism and the Moral Hazard

Mises Daily: Tuesday, April 08, 2003 by

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Many supported the war in Iraq due to the supposed increase in security we will experience at home once Saddam is out of the picture. But who really feels safer in the its aftermath? Why do government's warnings of impending doom seem to be increasing rather than decreasing? Why has the government even put up a new website (www.ready.gov) that makes the most paranoid survivalist literature seem moderate and sane by comparison? 

Last November, even as the government was preparing its war on Iraq, President Bush signed legislation into law that required insurance companies to offer terrorism insurance for possible 9/11-like terrorist acts in the future.

That's interesting. A reduced threat of terrorism would suggest less need for precaution. If the government actually believed that the homeland would be safer due to its actions overseas, then why does it impose (under the threat of violence) the insurance requirement?  

Others seem to see the war in Iraq itself as a form of insurance. They justify it as a necessary response to the shocking events of September 11, 2001, as though the Iraqi regime organized and executed those attacks (no connection has ever been demonstrated). By not responding forcefully, the U.S. would be sending a message of weakness to that and similar governments. The billions of dollars spent on this military venture and those that follow represent insurance payments to reclaim the level of safety many took for granted before 9/11.

The country singer Darryl Worley, cashing in on this public mood, has recorded a popular song entitled "Have You Forgotten?" that explicitly makes this point. This sentiment is epitomized by the comments of a college student quoted in the New York Times:  "It's the security of the United States that's at issue. They're saying that the only way we can ensure the security of our citizens is to go in there."  

This reasoning behind the hysteria follows the theory of blowback, the idea that angering and alienating millions of people must result in some organized-and-yet-unknown future retaliation. Government officials know that their policies will lessen security, not increase it, and that a world with terrorism insurance will make life more tolerable than a world without it. The electorate will more likely accept these policies if their costs, in terms of blowback, are softened by terrorism insurance already in place.

This raises the problem of moral hazard to a different and dangerous level. Moral hazard problems result in any insurance program when the insured parties engage in risky behavior because of the existence of the insurance. It is well known, for instance, that people drive more recklessly when they receive high levels of automobile insurance at a low cost.

To minimize these problems, insurance companies charge higher premiums to individuals who engage in high risk activities to force the cost of their activities onto them and to force them to assume responsibility for their actions. Therefore, the policyholder with multiple accidents must pay higher premiums, and the smoker who refuses to shun tobacco is forced to pay more for his health benefits.

Such is the economic logic of the link between consumption and payment. If you choose to continue smoking, or if you choose to continue to engage in reckless driving, you will pay more for insurance. If you don't, then you will be forcing the costs of your actions on to others in the form of higher insurance costs, socializing the benefits you get from owning insurance onto remaining policyholders.     

The same relationship between consumption and payment does not apply to terrorism insurance, because those who are forced to purchase it are not the same people who increase the likelihood of increased costs in the future from their actions. The situation would be analogous to a smoker who uses the state to force others to pay for his insurance coverage to compensate for health problems that result from his plans to continue to smoke in the future. In the same way, by forcing insurance companies to offer terrorism insurance, the government enables itself to engage in activity that increases the likelihood of terrorist strikes at home.

Real terrorism insurance would imply systems that reward those insured for moderating their behavior. When running for president, Candidate Bush argued for a "more humble foreign policy," and until one is implemented it is not likely that there will be reduced terrorism at home. This can only be achieved by increasing the scope of voluntary cooperation between individuals, or by favoring the scope of voluntary market transactions over state power. In other words, to insure for a world characterized by peaceful international relations, you must give trade a chance.

Free trade draws men and women together by making them interdependent and thus creates the conditions necessary for civilization. On the other hand, "government interference with business and socialism," writes Ludwig von Mises in Human Action (The Scholars Edition, pp. 819–20) "create conflicts for which no peaceful solution can be found. …  What has transformed the limited war between royal armies into total war, the clash between peoples, is not technicalities of military art, but the substitution of the welfare state for the laissez-faire state."

Many such substitutions will result from the war in Iraq and those that follow it, enabled by government interventions encouraged by terrorism insurance. This explains, to a large extent, the opposition to the war from the Right. Nondefensive wars never expand freedom in the world. The health of the state and the health of civilization are mutually exclusive concepts.

Too bad such thinking can't be written into a country song.


Christopher Westley, Ph.D., is an assistant professor of economics at Jacksonville State University. See his Mises.org Daily Articles Archive. Send him MAIL.