Manufacturing Discontent : The Trap of Individualism in Corporate Society (9781783718481) by Perelman Michael

Author:Perelman, Michael
Language: eng
Format: epub
Publisher: Lightning Source Inc

RISK, UNCERTAINTY, AND PROFIT

Despite Wriston’s questionable credentials as an objective advocate of requiring individuals to accept the adverse consequences of risk, virtually every economist accepts the fact that risk plays a central role in market economies. How could the situation be otherwise? However, as I will show, more often than not it is private individuals or society at large that bear the risk, while corporations enjoy the rewards. Before addressing that subject, I will first discuss the nature of risk, and a related term, uncertainty.

By risk, economists mean something that can be assigned a specific probability, such as flipping a coin. I do not know when I flip a coin whether it will come up heads or tails, but I can be fairly certain that if I do so 1 million times, tails will come up in close to half the flips.

In the case of the coin flip, suppose that you are betting that you get two coins if you get heads and nothing if you lose. The expected payoff of the bet is one-half of two plus one-half of zero—or a total of one.

Obviously, reality is far more complex than a simple coin flip. Even so with more complex bets where all the odds are known, you can still calculate the expected payoffs. Life insurance is based on this sort of calculation. So, assuming that people are rational and known odds are known, analyzing risky situations is not much more difficult than evaluating decisions where the outcome is certain.

Economists distinguish between risk and what they call uncertainty. Uncertainty is something altogether different from risk. Uncertainty refers to conditions in which nobody can possibly know what the likelihood of an event may be. For example, the late Danish physicist, Per Bak, capped his career by studying the seemingly trivial subject of the physics of sand piles. You can continue to build a pile of sand until a point comes at which a particular grain will set off an avalanche. Bak showed the impossibility of predicting which grain will trigger the event or how high the pile will have to be before it occurs (see Bak 1997). Similarly, nobody can know what the next outbreak of a new disease will be. Fifty years ago, who could have predicted the AIDS epidemic?

Of course, people are not rational at all in managing personal risk. People often avoid slight risks, yet take wild gambles.

Risk does not present a great complication for the smooth running of a market economy, but uncertainty does. So, to be precise, we should translate the risk Wriston refers to as uncertainty. Within the context of market economies, uncertainty is pervasive. In a market economy, producers have no legal mechanism to coordinate their actions with other producers. Without knowledge of the intentions of consumers and competitors, business cannot reduce uncertainty to calculable risk.

True, as information accumulates, people may be able to transform some uncertainty into risk. For example, over the centuries people learned about certain regularities in weather patterns. Yet, despite

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