Coping with uncertainty

Topics BOOK REVIEW

In order to provide relief from the pandemic, governments across the world are piling on debt and large central banks are liberally printing money
A book on uncertainty could not have been better timed. Although Radical Uncertainty: Decision-making For An Unknowable Future  was written in the pre-Covid-19 world, the uncertainty associated with the pandemic has increased the importance of understanding the limitations of managing risk in various aspects of life, business and policy making. The book, as the authors describe, is about “how real people make choices in a radically uncertain world, in which probabilities cannot meaningfully be attached to alternative futures.”

This is exactly how governments, businesses and people in general have been functioning over the last few months. It was impossible for almost anyone to anticipate, though the book refers to the risk, that a virus could wreck the global economy in the 21st century. Output is likely to contract in most parts of the world in the current year, government deficits and public debt are soaring, and there is no clarity as to when normalcy will return. But the reason even the most intelligent minds often fail to discount uncertainties is perhaps that this is how it is supposed to be. Not enough attention is being paid to the difference between risk and uncertainty.

However, as Interest and Money noted: “By ‘uncertain’ knowledge, let me explain, I do not mean merely to distinguish what is known for certain from what is only probable…The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealth-owners in the social system in 1970. About these matters, there is no scientific basis on which to form any calculable probability whatever. We simply do not know.”

Radical Uncertainty: Decision-making for an unknowable future 

Author: John Kay and Mervyn King

Publisher: The Bridge Street Press

Pages: 544

 
Price: Rs 799

 

But, with the focus of the subject itself, the understanding of risk and uncertainty changed over time. Milton Friedman in A Provisional Text  argued: “In his seminal work, Frank Knight drew a sharp distinction between risk, as referring to events subject to a known or knowable probability distribution, and uncertainty, as referring to events for which it was not possible to specify numerical probabilities. I have not referred to this distinction because I do not believe it is valid…We may treat people as if they assigned numerical probabilities to every conceivable event.”  The concept of uncertainty, as underscored by Keynes and Knight, lost relevance over time.

As a result, in practice, since it was possible to assign probabilities to every possible outcome, risk could be priced and contained. It worked all fine until radical uncertainty made a comeback. Instruments designed to contain risks in the financial system themselves threatened to bring it down in 2007-08. In early 2007, the Northern Rock bank in the UK, for instance, declared to its shareholders that it was the best-capitalised bank in the country. Perhaps no one in the bank or elsewhere anticipated how vulnerable the state of its balance sheet was. The bank ran out of money in a few months. A similar story played out in several financial institutions on both sides of the Atlantic Ocean.

Mr Kay, the first director of the Said Business School at Oxford University and a Radical Uncertainty  does not specifically talk about the current challenges, the broader context would help the reader apprehend the situation with greater clarity, question popular wisdom, and improve decision- making. As the authors rightly note: “Real households, real businesses and real governments do not optimise; they cope.”

Despite all the economic understanding and technological development, this is exactly what is happening. In fact, this is how things are all the time. It’s just that the uncertainty is more pronounced now. Although the world is grappling with numerous uncertainties, here’s one worth pondering. In order to provide relief from the pandemic, governments across the world are piling on debt and large central banks are liberally printing money. This is probably the right thing to do in the given circumstances, and it is likely that governments and central banks will continue with these policies. But are there limits to such policy interventions? Maybe. How will all this end? Well, who knows!


Business Standard is now on Telegram.
For insightful reports and views on business, markets, politics and other issues, subscribe to our official Telegram channel