Working Paper: NBER ID: w2666
Authors: Richard Arnott; Joseph Stiglitz
Abstract: There is a widespread belief that when significant market failure occurs, there are strong incentives for non-market institutions to develop which go at least part of the way to remedying the deficiency. We demonstrate that this functionalist position is not in general valid. In particular, we examine a situation where insurance is characterized by moral hazard. We show that when market insurance is provided, supplementary mutual assistance between family and friends (unobservable to market insurers) -- a form of non-market institution -- will occur and may be harmful. This example suggests that non-market institutions can arise spontaneously even though they are dysfunctional.
Keywords: market failure; nonmarket institutions; moral hazard; insurance
JEL Codes: D82; G22; I38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Market failure (H49) | Emergence of nonmarket institutions (D47) |
| Emergence of nonmarket insurance (G52) | Adverse economic outcomes (F69) |
| Nonmarket insurance (G52) | Crowding out of market insurance (G52) |
| Provision of nonmarket insurance (G52) | Welfare-improving contingent on observation (D69) |