By: Larry MacDonald

Here is one reason why I tend to be apprehensive about plans to increase government spending, like was done in Budget 2009:

Employment insurance program posts nearly $150M loss to fraud

This article appeared just before the budget and reported that the Employment Insurance (EI) program lost $150 million to fraud last year. In the article, government officials claim much of the stolen money will be recovered, although I’m not so sure: it seems to me that berry-picking operators like the one mentioned in the article can avoid returning funds by going out of business and/or re-opening under a different name.

Moreover, the fraud that is detected is often just part of the iceberg. Much more of it usually goes undetected. Even if all misdirected funds were perchance recovered, there is still the cost of the administrative apparatus required to monitor and enforce compliance. In the case of the EI program this is an ongoing cost: the amount of fraud has never been less than $100 million annually over the past eight years.

Bureaucrats who manage the public purse don’t have an ownership stake in the monies, so they aren’t as motivated to look after it as would the original owners. This is a classical problem that economists call “agency risk.”

From one perspective, a great deal of the current financial crisis is due to unchecked agency risk. Banks in the U.S. gave mortgages to high-risk home buyers because they could ship those mortgages off their balance sheets into securitized packages for sale to institutional investors. Investors blindly trusted the Madoffs of the world with their money. Managers of corporations diverted billions of dollars into lavish lifestyles and bonuses. If people were more vigilant of agency risk, financial crises like the current one would have less probability of occurring.

One wonders if judgment day will come for the public sector too. How much longer can governments continue to expand their budgets without addressing agency risk in public administration? There is not only a financial impact but a social one (speaking for myself, it’s somewhat demoralizing to toil away for a living only to see others secure theirs’ with lower ethical standards).

And in the case of EI, why does the amount of fraud remain so high year in and year out? Maybe it’s because penalties are too small to provide a deterrent effect.