More than cost shifting: Moral hazard lowers productivity

A substantial number of papers have shown that as workers' compensation statutory benefits increase, reported claims frequency and severity also increase. While this seems to be a robust finding in the literature, it is not known how these moral hazard responses affect real productivity. Moral hazard is usually regarded as shifting costs from group health medical to workers' compensation medical, or from absenteeism to workers' compensation disability, with no real consequences on the output of firms. But moral hazard can reduce output in two ways: (1) in the misallocation of inputs due to "bad" cost information, or (2) in the loss of specific human capital, controlling for the allocation of other inputs. We employ two data sets to analyze the impact of the second effect, reduced manufacturing output due to the loss of specific human capital because of moral hazard. We find significant effects: a 10 percent increase in benefits leads to an estimated decrease in output, ranging from .3 to 4 percent, depending on specification.