Before the formal revolution in economics (let's date it to Samuelson's 1947 Foundations), the distinction between risk and uncertainty was well understood by Keynes and Knight (ideologically far apart). There is a crisp (Knightian) distinction between (measurable) risk and (unmeasurable) uncertainty (as regular readers of this blog know (see also, here, here), I am fascinated by it.) In fact, the loss of this distinction in modern economics is a nice example of a so-called "Kuhn Loss" (that is, insights of past theories that cannot be articulated or recognized by the new theory). In particular, in the new technocratic and mathematical policy science of economics uncertainty became equated with randomness. (So that in effect all events fell under risk.) One consequence of this is that economists as policy-scientists ">trade in numbers where they really should be developing precautionary principles, institutional design that can withstand crises, and help develop an ethos that can prevent crises. (My obsession with crisis prevention is a consequence of the fact that given political realities, the have-nots tend to suffer disproportionaly during crises.)
I had long assumed (based on some research) and have reported in this weekly blog that two of the driving spirits of the formalization of economics -- Paul Samuelson and Kenneth J. Arrow [both Nobelists] -- were responsible for driving out genuine uncertainty and replacing it with randomness inside economic theory. But in re-reading Arrow's classic attack on Knightian uncertainty (where Arrow commits what Taleb, from Black Swan fame, calls the "Ludic fallacy," that is treating well understood games of chance as exemplaric for all decision) he credits the idea to another famous paper by a very well known (among economists) economist : Armen Alchian, who is thought of as the founder of new institutionalist economics, and significant for the economics of information and evolutionary approaches to economics. (He is also the founder of the way 'Chicago' economics was practiced at UCLA.)
I have read Alchian's paper before because In his famous 1953 methodological article"> (which is directed AGAINST the kind of economics that Arrow and Samuelson are proposing), Milton Friedman is clearly indebted to the evolutionary arguments from Alchian (as Jack Vromen has explored in his work. But with Arrow's reference in mind, the final paragraph (which I quote below in full) takes on a new kind of significance. In particular, ALCHIAN is prophetic in articulating the way of economics as a policy science for the next half century or so. If folk want to understand the sources of so-called neo-Liberalism, they could do worse than to study this piece of writing (to be followed with close study of Oskar Lange (recall my blog here)).
I quote Alchian without comment. He writes: "The approach suggested here is intellectually more modest and realistic, without sacrificing generality. It does not regard uncertainty as an aberrational exogenous disturbance, as does the usual approach from the opposite extreme of accurate foresight. The existence of uncertainty and incomplete information is the foundation of the suggested type of analysis; the importance of the concept of a class of "chance" decisions rests upon it; it permits of various conflicting objectives; it motivates and rationalizes a type of adaptive imitative behavior; yet it does not destroy the basis of prediction, explanation, or diagnosis. It does not base its aggregate description on individual optimal action; yet it is capable of incorporating such activity where justified. The formalization of this approach awaits the marriage of the theory of stochastic processes and economics-two fields of thought admirably suited for union. It is conjectured that the suggested modification is applicable to a wide class of events and is worth attempts at empirical verification.''"17
The concluding note 17 reads: "Preliminary study in this direction has beenvery convincing, and, inaddition, the suggested approach appears to contain important implications relative to general economic policy; but discussions of these are reserved for a later date."
Recent Comments