Frank Knight was one of the first economists to clearly describe the difference between risk and uncertainty. Risk is something for which the probability distribution is reasonably well understood ex-ante. For example, if you secure your daily bread by a coin flip, we can understand the likelihood that you will obtain a meal upon any given toss of the coin. These risks can be pooled so as to insulate all members of society from them. While any one of us has no idea whether we will in fact experience an adverse outcome, if what we are facing is true risk, then we can get pretty near certain that a known share of the population will experience a loss. Thus, we can collect premiums to help offset the adverse outcomes should these risks turn to reality for a particular person.
Contrast this to uncertainty. When we discuss uncertainty in economics, we mean by invoking the term uncertainty and not risk that there can be no known distribution a priori. If we do not understand the probability of something ex ante, we enter an entirely different realm than when we are thinking about risk. Perhaps I’ll blog Knight’s classic, Risk, Uncertainty and Profit in the future. But I wanted today to merely rehash an observation made recently by Lynne Kiesling.
We can think about the difference between information and knowledge in much the same way that we can think about the difference between risk and uncertainty. The reason this is important is that the task of central planners would be vastly simpler (i.e. possible perhaps) if all we faced in an economy was an information problem. If our task as planners was simply to learn the values different consumers place on all kinds of (potential) goods, and what resources are required to produce various goods and who can use them more or less efficiently, you might think that with a good enough supercomputer the dreams of Lenin and his mates could someday be realized. But, the “stuff” that is important for most economic decision-making is not mere information but rather is knowledge. What is knowledge? It, like uncertainty, is something that cannot also be described with an ex-ante probability distribution. In fact, the major insight of Hayek’s work in the late 30s and 1940s is that the knowledge required for economic decision-making is not likely even known by the actors themselves even as they are making the decisions that are relevant. It is not that knowledge is available but at some cost to obtain, it is that knowledge itself is endogenously determined by the market process. In other words, without the discovery and learning that happens as part of a market process, the knowledge that is needed for economic decisions can never be generated.
I can imagine some folks think this insight is in the spirit of the joke about economists stranded in the desert assuming a glass of water. Quite the contrary. Hayek in his psychological work, The Sensory Order, and others since, have demonstrated that knowledge is different from data and facts, it is not objective, and does not just consist of knowledge related to preferences and costs, but perhaps most important includes institutional knowledge – the formal and informal rules, grounded in custom, by which we cooperate with one another – and that these rules evolved over time to be robust and requirements for complex orders to continue to prosper (he made these arguments much clearer in Law, Legislation and Liberty than he did in Constitution of Liberty). I propose that one reason these arguments are not often engaged with is that they are “a”moral and unemotional. That’s too bad, and it’s perhaps too bad that Hayek himself tried to behave calmly as he made these observations. That’s not exactly the approach some other famous intellectuals take today.
this is incredibly insightful but will no doubt fall on deaf ears
What a great title, WC.
Mark, it is not falling on deaf ears. Wintercow packs ’em in in his classes. Ideas go viral these days.
On a related subject, Angela Merkel declared an end to Germany’s solar energy program. What is the German phrase for, “We don’t know Jack”?
have you been to his intro econ class!