William Baumol provides the beginnings of a moral hazard theory of government
production.'27 His insight is best introduced with an example: the provision of
national defense. The common rationale for the provision of national defense by government
rests on the argument that it is a public good. But this is only as argument
for government intervention, not a public army per se. Baumol's case for a public
army is made in terms of moral hazard. A government intends to use its armed
forces only when needed for its own purposes. An army provided by the market to
the government under contract may have very different incentives that bring into
question ~tlsoy alty and reliability.
We suggest that the moral hazard problem can be viewed more broadly in the
context of opportunism. Again, we can illustrate the crux of the problem using the
example of national defense: Armies cannot be trusted to carry out the contracts because
the government does not have an independent mechanism of enforcement. In
other words, the armies are in a position to engage in opportunistic behavior, like the
soldiers in the Thirty Years' War who were lured from one side to the other with
bonuses and higher wages.'28 Even if a particular private army does not engage in
such behavior, the state will inevitably be forced into costly monitoring. For instance,
the government would at least have to establish an office of inspector generdl
to make sure that the contractor can actually muster the promised forces.