Topic: Economic Policy
In Defense of Risk and Uncertainty by Jeff Peters
(conservative)
Friday, March 13, 2009
Everyone loves to talk about risk and uncertainty; especially in times when people are expecting wide spread economic disaster. Apparently, to many the solutions to our problems involve removing risk from the economy in order to avert these potential disasters.
In general I'm against measures that aim at reducing risk as produced naturally from the free market place.
Firstly, why is there a natural rate of uncertainty in market transactions? There are many reasons why. Incomplete or asymmetric information introduces an element of risk. When we don't have all the information we desire about a particular product or transaction, we would either avoid purchasing the product, or we would take a risk and purchase the product on a probability that it reflects what we desire. For example, will the value of this stock go up in the next couple of days?
When people engage in these sorts of transactions that do not have stable values, they understand there's an element of risk involved. This implies, that when they lose their money, because the actual outcome of this transaction is against their favor, they must take responsibility for engaging in that risk. Sometimes randomness will work in some person's favor, but sometimes it won't.
However, people engage in risk because that's where they expect to maximize utility, consumer welfare, or payoffs. In other words, people take risks because they are comfortable with taking those risks - not because some exogenous entity forced them to do so.
This means a lot for how we talk about risk. Morally superior cranks who are always talking about constraining the risks people take, need to understand that the taste for risk exists "from within," if I may use wishy-washy terms. In matter of fact most people are risk averse - as they will take a risk if they think they will be compensated very nicely relative to what they might lose. In general, consider the important point - it's a matter of expectations and its relation to preference of risk.
However, people will take even greater risks if they are provided with some insurance or a risk premium. Government bailouts are just risk premiums that aren't placed in insurance contracts. It's also the reason why the government ought to take cautious steps when giving money to companies. Otherwise, they wouldn't mind making very risky decisions in search of large payoffs.
The role of risk in the consumer demand and producer supply is far too huge and important to try to eliminate for the reasons given above. The most important part being: if we don't take risks and learn how to manage and strategically reduce it our everyday lives, we are essentially eliminating the potential payoffs.
What are those payoffs? They are comfort, future financial stability, and just all around happiness. Don't live a complete boring life for fear that something awful will happen. In conclusion, take all the risk you desire, but learn how to use it to your advantage. In matter of fact, the market already has incentives propped up for you to do that if you are risk averse. If you fail, you will pay the price and hopefully learn how to better manage risk in the future.
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The views expressed in this
article are those of Jeff Peters only and do not represent
the views of Nolan Chart, LLC or its affiliates. Jeff Peters is
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employee or otherwise affiliated with Nolan Chart, LLC in his/her role as a columnist.
Excellent Chris! A good percentage of the bank bailouts and definately AIG, fanny, freddie could probably be declared direct insurance payments due to investment risk from failing mortgages. We are not only trying to eliminate risk but to "insure" insurance! The order of payment is also very interesting, who is first [the bigs] and who is last [little guy].
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