Radical Uncertainty (John Kay & Mervyn King)
In his seminal book The Open Society and its Enemies, Karl Popper distinguishes between laws of nature and social laws, noting how in most earlier societies there was no distinction, since people ascribed natural phenomena to deities or rulers (often one and the same). In Radical Uncertainty, John Kay and Mervyn King note that it wasn't until 1654 that Pascal and Fermat created a theory of probability, and 150 years later Laplace formalised this theory - despite the ancient Greeks tackling more difficult mathematics 1500 years prior. Perhaps because floods, famines and earthquakes were seen literally as acts of God(s), uncertainty was late to the intellectual party, explaining why were are seemingly so bad at it. Or perhaps we are better than we realise, and it is economists and social scientists who need to catch up with ordinary people.
John Kay and Mervyn King's book about uncertainty is of course, well timed. Central to the book is the distinction between those things that can be quantified and assigned a meaningful probability (known unknowns), and those questions to which no probability is meaningful (unknown unknowns), and to assign them one is often harmful. Some things in the future can never be known. If I know I will invent the wheel next week, I have invented it already. Because probability theory has amazing predictive powers when things are static or normally distributed - for example life expectancy - this theory is too often applied in the wrong domains, argue the authors.
Anyone who is familiar with Nassim Taleb's Incerto will have a sense of Deja Vu reading this book, since the themes and many of the examples are the same; nonetheless it is a worthwhile read. Concentrating mostly on economics and finance, the book is littered with a broad set of illustrative examples from Osama Bin Laden's death to The Cuban Missile Crisis to the HS2 Rail Project.
The book's preface warns the reader that "specialists" (read economists and social scientists) find it difficult to accept the concept of radical uncertainty, whilst general readers find it obvious. For me, this is the central takeaway from the book - the erroneous academic methods for handling uncertainty for the past 100 years have evolved, but are still far behind day to day risk management by ordinary people - which is often labelled irrational or inefficient.
After the Second World War Milton Friedman, Paul Samuelson and others formalised economic theory into mathematical language, using assumptions about human behaviour that whilst untrue, arguably made the models useful ("homo economicus or rational man"). Both Frank Knight and Keynes, the leading economists of the previous generation, had warned against this, distinguishing between quantifiable risk and unknowable uncertainty. But still the modellers won the day - perhaps because the prestige of economics as a 'science' was enhanced by making the discipline look more like physics to an outsider. One of the consequences of this formalisation was the increased confidence of predictive models in economics, indeed the Nobel laureate Robert Lucas said in 2003: “Macroeconomics… has succeeded: its central problem of depression prevention has been solved, for all practical purposes, and in fact has been solved for many decades.” The 'Great Moderation' from the fall of the Berlin Wall up until the financial crisis brought about hubris in academia from which the authors were not immune.
The Israeli empirical psychologists Daniel Khaneman and Amos Tversky demonstrated with many experiments how the assumptions of rational behaviour were wrong (we can prefer apples to pears, pears to oranges and still prefer oranges to apples). Yet Kay and King show that the discipline of Behavioural Economics that sprung from Khaneman & Tversky's work offered no panacea. Nobel Prize-winning economist Richard Thaler was able to show how 'nudges' could positively and cheaply affect behaviour - for example having carrots at eye level rather than fries in a canteen increased carrot consumption, or changing 'opt in' to 'opt out' on a form could increase pension-scheme participation. But this discipline still purports to know what is rational better than the general public, and in a world dominated by radical uncertainty, how can it? What may look 'risk averse' in a purely 'utility maximisation' framework may just be factoring in those risks which we cannot - ever - anticipate. Indeed, subsequent work (not mentioned in the book) on ergodicity economics by Prof. Ole Peters offers a better explanation for risk aversion.
Our failure to act according to models may not be our failure but that of the models. The authors point out that we may not be taking out insurance to maximise our utility, but to protect the narratives of expected outcomes. We insure our phone or luggage on holiday even though we can afford to replace it, because it offsets the potential bad feelings we would have of such an occurrence. It makes better sense from a purely rational perspective to have cheap insurance with a high excess - but no one will buy it because the bad feeling of losing your stuff needs to be offset by a good feeling of being insured in full. Who is to say that is a wrong choice?
Radical Uncertainty is, more than anything, a critique of policymakers and academia's approach to the business of uncertainty. There are puzzles and mysteries, and just because we wish all uncertainty to be a solvable puzzle doesn't make it so. Groups don't behave as a collection of individuals. We are not consistent in our choices. We can be 'overly optimistic', but if we weren't we wouldn't start businesses. We can be 'overly pessimistic', but if we weren't then we would be killed more often by pandemics. The fact that our ancestors have survived with such 'biases' indicates that we may know more with our instinctive behaviour than the professors. Professor Matt Carre of the Department Of Sports Engineering at University of Sheffield said of David Beckham's famous free-kick goal against Greece: "Beckham was instinctively applying some very sophisticated physics techniques when scoring that goal." Beckham wouldn't actually be capable of making those calculations, but Dr Carre would. Who would you rather took the free kick?