Dysfunctional Non-Market Institutions and the Market
NBER Working Paper No. 2666
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.
Published: American Economic Review, "Moral Hazard and Non-Market Institution: Dysfunctional Crowling Out or Peer Monitoring?" Volume 81, pp. 179-190 1991