Risk and Uncertainty, the 6234th


Summer time gives you the opportunity to read good books. I am now reading Jens Beckert’s new book . I will present some thoughts on it in following blogs. Now I wish to concentrate on one fundamental point that is not specific to this book. Beckert’s book is about the role of time and expectations in capitalism. He rightly emphasizes that there is a long tradition in economics in discussing these phenomena, and he also refers to the famous distinction between risk and uncertainty that was made by Frank Knight.

This distinction is recognized by most economists. When reflecting on this, I realized that behavioural economics, as far as I know, does not systematically discuss uncertainty. In the recent rise of behavioural economics, beginning with the Allais paradox, researchers only concentrate on human failures in dealing with risk as measured in probabilities. Considering Knight’s distinction, and important foundational contributions to economics such as Keynes’ theory, we can legitimately raise a disturbing question: Is that really relevant for understanding economic action in real life?

Surely, there are areas where probabilities really matter, such as in managing risk via the institution of insurance, and people may indeed err in assessing the relevant parameters. But if we move to core areas of the economy, such as entrepreneurship and investment, technological change or even innovative consumer behaviour, uncertainty looms large. Probabilities do not count – but that implies that human failures in dealing with probabilities do not matter either. Well then, what is a cognitive failure with reference to uncertainty?

The case for probabilities in behavioural economics is clearly based on that we have a clear and exact standard in identifying deviations as ‘irrational’. But for uncertainty, no such standard exists. As long as behavioural economics research strategy is wedded to the notion of anomaly, we cannot reasonably talk about failures in dealing with uncertainty, al least in terms of ‘rationality’. I think that this is big problem, and raises doubts about the relevance of mainstream behavioural economics for understanding the real economy.

For example, picking up earlier blog posts, if you deal with uncertainty, narratives may be seen as devices to cope with it and establish workable frames for action. Akerlof and Shiller see narratives as ‘animal spirits’, and Kahneman and others outrightly condemn narratives as being detrimental to genuine rationality. Bu all these arguments explicitly or implicitly build on the probability theory frame. Considering uncertainty, methodological standards change fundamentally.

Interestingly, Beckert points to pragmatist philosophy as the most appropriate frame, especially Dewey. In this view, dealing with uncertainty requires the capability to launch and manage complex trajectories of experimental experience in doing things, while constantly revising your projections of the future, especially including even the goals of the action. Action facing uncertainly must be reasonable, and cannot be ‘rational’ in the mathematical sense.

Thinking about capitalism, uncertainty is its central phenomenon, not risk. One could even argue that risk is mainly relevant in pre-capitalist societies. Why? In pre-capitalist societies, the state space of the economy does not change, because there is few innovation, and many constraints are stable in the long run, though including variations (such as weather). In capitalism, the state space changes continuously, which can neither be fully overlooked in the present, nor predicted for the future. Therefore, pre-capitalist people may make use of probabilities, but capitalists need other cognitive frames. I think we can even justify this with neuroeconomic and behavioural economics insights: We know that failures of probability assessments mostly happen if they are represented in numerical terms but vanish if people build implicit judgments of probabilities via experiencing frequencies of events. Well, that shows that pre-capitalist environments created adaptive pressures to deal with probabilities without maths!

Beckert, Jens. Imagined futures: fictional expectations and capitalist dynamics. Cambridge, Massachusetts: Harvard University Press, 2016.

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