Read: Risk, Uncertainty and Profit

  • After years of pointing out the difference between risk and uncertainty – without actually discussing the consequences for economic analysis in detail – to my students in economics it is time to finally read the classic Risk, Uncertainty and Profit (pdf) by Frank H. Knight.

    The obvious lesson is learned, I am prepared and eager to discuss the implications of uncertainty in class now. (It is sad that these very important points never made it into the textbooks.)

    There were, however, a few other observations that I made while reading Knight’s dissertation.

    First, the four prefaces give a nice glimpse into the change and constancy of the (history of) economic thought (of at least one influential scholar) at their time. These prefaces are worth reading even without the intention to continue into the main text.

    Second, just a hundred years ago German economic scholars were read (in German no less) and cited, discussed and indeed at the frontier of their science. I knew that before, of course. Still, it is nice (?) to be reminded of this fact. A lot has happened since.

    Third, there are some points that, I guess, no author today would make, at least not en passant as Knight did, e.g. (on p. 320): > The abolition of slavery or property in human beings rests on the fact that slaves do not work as effectively as free men, and it turns out to be cheaper to pay men for their services and leave their private lives under their control than it is to maintain them and force them to labor.

    Fourth, it is very clear why Knight is one of the intellectual pillars of the Chicago School (though his ideas and perspective is markedly different from the later / modern neoclassic approach), or rather Chicago Libertarianism. According to Knight, Freedom, the power of control, is and should be inseparably linked to responsibility, the willingness to bear the consequences of one’s own decisions (p. 271):

    …at the end of it we shall find that in a free society the two [responsibility and control] are essentially inseparable. Any degree of effective exercise of judgment, or making decisions, is in a free society coupled with a corresponding degree of uncertainty-bearing, of taking responsibility for those decisions.

    Finally, and here I have to admit a bit of surprise on my side, given his status as the foundation of the Chicago School of economics I did not expect his deviations from today’s orthodoxy with respect to individual rationality as expressed by (p.238):

    We should not really prefer to live in a world where everything was “cut and dried,” which is merely to say that we should not want our activity to be all perfectly rational. But in attempting to act “intelligently” we are attempting to secure adaptation, which means foresight, as perfect as possible. There is, as already noted, an element of paradox in conduct which is not to be ignored. We find ourselves compelled to strive after things which in a “calm, cool hour” we admit we do not want, at least not in fullness and perfection. Perhaps it is the manifest impossibility of reaching the end which makes it interesting to strive after it. In any case we do strive to reduce uncertainty, even though we should not want it eliminated from our lives.

    and (p.331):
    > The desire (or necessity) for conforming to conventions is not the same things as the need for food and protection; the easy fallacy is confusion of the requirement for food, clothing, and shelter of the conventional kinds with the requirement for food, clothing, and shelter as physiological necessities. A large part of the consumption of persons, in the lower income strata even, does not yield satisfaction as consumption; the motives and cravings are social in their origin and nature. It is commonplace that many of the necessities of to-day did not exist or were not available for our ancestors a few generations ago, irrespective of their wealth.

    And yes, he knows, of course, of Veblen’s work. Even though he did not cite him in this context.

    There is more: A lot is happening in the footnotes. He is not at all shy with pointing out flaws in the argument of others. There is no list of references.

    Overall it is obvious, I should read more of the classics.