The Two Faces of Risk; E. Ross

ErnestG. Ross ASSESSINGRISK these days is a risky business. In times when we are de regulating our economy, are we to assume that risk will be increas ing-or decreasing? Should we ex pect that businessmen will face greater risk-or lesser? Will the "dog eat-dog" world of purer capitalism force entrepreneurs to take more dangerous chances than under a controlled economy-or more be nign ones? In short, how do we judge the importance of risk in our future? Judging anything requires that one start with a standard. Judging without one is like measuring with out a common unit. What can we use as a unit of risk-measurement, as our standard for judging risk? Mr. Ross is an Oregon commentator and writer es pecially concerned with new developments in human freedom. Risk means the possibility of los ing something of value. If so, our standard involves the pursuit ofval ues. Economically, a value is any thing an entrepreneur wishes to ob tain or retain in the marketplace.

(This is the Austrian School of eco nomic values-which says that in dividuals create their own values by the choices they make-i.e., that values do not exist independent of man's decisions and actions.) What is the condition of the mar ketplace which most enhances one's ability to obtain or retain values for instance, to start a new business, to create new goods and services, to secure new markets, to earn a profit? What is the condition which offers the greatest number of opportuni ties to pursue one's goals? It is, of course, freedom-the condition of 707 708 THE FREEMAN December human action which exists in a so ciety when only the first-use of force (or its threat) and fraud are out lawed. Minimizing Risk When only coercive or fraudulent activities are forbidden, all else is open to entrepreneurial pursuit-in other words, open to all of us, for in a free society because we must make our own economic decisions and take our own economic actions we are all entrepreneurs. In a most fundamen tal sense, freedom gives us the greatest number of options for gain ing and preserving any economic values we might choose to pursue or defend. In the widest view, when op tions are maximized, risk is mini mized. This is not the conventional view, which holds that freer people face greater risks.

Examine the point from another angle-from the angle of a con trolled economy or an anarchistic one where the first-use of force and fraud are not outlawed. What happens to one's options for obtaining or retain ing his values then? The essential economic character istic of societies which accept force and fraud is that markets do not have to be earned, merely taken. Consider monopolies. Monopolists can both gain and secure their markets by compulsory laws of all types forbid ding others from selling or dealing within a specified territory or in a specified category of goods and ser vices-or, in the case of anarchies, by intimidation ("Buy from us-or else!")! This internal protectionism favor ing the force-wielders' business friends drastically restricts one's market opportunities and his op tions for minimizing the possibility of losing his values-for minimizing risk. Because in controlled societies most if not all categories of economic activity are restricted, openings for entrepreneurs are severely con strained. One cannot initiate new economic action when nearly every field of endeavor is locked up and coercively protected for the politi cally favored and powerful.

Now under such conditions, be cause nearly everyone is also "guar anteed" a job (or forced to take one), it may appear that most men are working under risk-minimized con ditions. But that is illusion. There is no greater risk to a man than to be totally at the mercy of coercive masters. The illusion of risk reduc tion masks the reality of absolutely enormous risk-the risk of being found "out of favor" with the state and thus deprived of means of self support, a deprivation which can amount to a sentence of slow death, or at best, abject poverty. The only persons who operate at minimized risk in a controlled soci ety are the controllers-but only so 1983 THE TWO FACES OF RISK 709 long as they hold the reins. The beast of coercion is difficult to ride. That is why a controlled economy is char acterized by a constant, deadly power struggle-a truly "dog-eat-dog" so ciety! In judging risk, it is crucial to dis tinguish between risk magnitude and risk diversity.

Risk magnitude is highest in com pulsion-based economies where the state lowers not only the responsi bility but the opportunity for pre serving life itself. Risk diversity is greatest in a free economy where each man is accorded not only the most options for success, but for fail ure as well. The difference is that fail ure under freedom is followed by the same opportunities for success which existed before the failure. In a controlled economy, failure is pun ished by total loss of opportunity one is "locked out" of the system and perhaps permanently marked as a failure; in a free economy, failure means only that one has failed this time-while the door remains open to all future options for achieve ment. Another way of putting this point would be that in heavily regulated economies there may be fewer risks to take, but each risk is more dan gerous. Of course, it is also possible to take dangerous risks in a free society but the dangers are cushioned: (a) One is not forced to take such risks; (b) he can often earn high rewards for severe risks; (c) he can (although sometimes at substantial cost) buy insurance in order to ease the im pact which failure might have on himself or his family; (d) except for death, he will never be completely locked out of further opportunities to better himself.

Thus, a free economy's dangerous risks are voluntary, compensatory, insurable, and limited; in unfree economies the same level of risk is "built-in" to the system-involun tary, not justly compensated, unin surable, and unlimited (except by death). How Attitudes Are Affected Naturally, these differences of dangerous risk magnitude depend greatly on how free or controlled an economy is. We live in a system which, like many modern ones, is a mixture of both. However, for the sake of clarity, let us briefly exam ine the "human" effects of the two faces of risk, risk in a fully free so ciety and risk in a totally controlled one-Le., how does each type of risk affect individual attitudes and be havior? First the bad news. The attitude toward risk in a con trolled economy is, "Don't take chances!" One can see why. To take a chance is to take one's life in his hands-to risk losing all of the ben efits of society if his superiors frown 710 THE FREEMAN December upon his thoughts, decisions, or ac tions. In effect, the price of risk in a controlled economy goes far too high for most people to afford. As a result, except for the risks which the state mandates on the individual (such as compulsory employment), he is ei ther prone to stagnation-or enters politics, the only arena in which the high price of risk may appear justi fled in society's "approved" channels of operation.

(The underground economy, the primary unapproved channel, is al most always a third option. But it, too, is dangerous, sometimes penal ized by execution, and almost al ways carrying stiff prison or labor camp terms. It is not uncommon for the average citizen to dabble in the underground economy-but most do not choose steady or deep involve ment because the risks are too dan gerous. This is especially true in controlled economies where the state has "turn in your neighbor" spy sys tems-as in the modem Soviet state.) If the citizen chooses the political road to success, he must, in effect, choose between being dominated or dominating. To use the vernacular, he must either "go with the flow" or control the flow. The important point here is that in either case whether one chooses to play serf or master-he will encounter much greater repercussions for risk-tak ing than will the citizen of a free nation.

High risk magnitude results in the controlled citizen being a less pro ductive one. Risk-taking is essential to productivity because innovation requires risk. Only innovation leads to new machinery and other labor saving technology which can im prove productivity. Raise the price of risk too high and you also prohib itively raise the price of productiv ity. (This, incidentally, is one reason why controlled societies bribe, steal, and cajole to obtain new technol ogy-their systems effectively in hibit the native risk-taking neces sary to produce their own high technology.) The burdensome cost of risk in a controlled economy also limits the variety of jobs available to the av erage citizen. When innovation and productivity are stifled, the state economy must employ more people fulfilling the "basic" needs (food, clothing, shelter, energy)-which necessarily decreases the number of people employable in other lines of work. And because low-productivity jobs (often called "labor intensive"

in American political circles) on bal ance require less-knowledge and less mental challenge, these jobs involve more drudgery. When risk is constantly too se vere, a terrible thing also happens to the spirit of a people-they lose their buoyancy, their lust for life. They become victims of a perpetual undercurrent of fear and apprehen1983 THE TWO FACES OF RISK 711 sion-which in tum erodes their self esteem. Without self-esteem, with out the feeling that life is worth liv ing because one can take risks with a good chance of being rewarded, no nation's citizens can maintain a truly human spirit. Their psychology be comes a twisted thing, defeated and deformed, the kind of spirit that views life not as a series ofopportu nities-but as a minefield. (This is perhaps why a common foreign ob servation about the freest citizens of the world, Americans, is: "They are so optimistic-and so unafraid!") Personal Initiative Stifled, Anxiety Takes Control There are other effects of the heavy risk level in controlled economies such as fewer consumer products, a lowering of the quality of all goods and services, an increased driving of economic activity underground with attendant official corruption, and so .

on-but the two most important ef fects are to stifle personal initiative and breed anxiety. The good news, of course, is that the free society type of risk does all of the opposite things: (1) It encourages people to take risks, to "Go for it!"-to progress rather than stagnate; and because the rewards for private market risk taking are so great, it discourages power-seeking. (After all, when one is already his own master, what real incentive does he have to dominate others in order to enhance his self preservation?) (2) It generates productivity to the greatest degree because people want to innovate in order to maximize personal satisfaction and material gain-i.e., happiness. (3) It creates a fantastic variety of jobs and business opportunities be cause the risk-taking-induced pro ductivity frees so many people from working in the basic needs indus tries. (As a dramatic illustration of this, look at the gargantuan size of the U.S. entertainment industry films, video tapes and games, books and magazines of all types, televi sion and radio, cable, music, sports, and on and on-as compared to the almost nonexistent entertainment industry of the Soviet Union.) (4) And, as earlier touched upon, it nurtures a love of life, an opti mism, a sense of self-esteem, and a spirit of opportunity-seeking.

So, to answer our original ques tion-as we move toward a less-reg ulated economy, should we expect risk to increase or decrease?-there are two parts: First, the sheer num bers, the variety, of available risk will be more. But, second, the sever ity, the dangerous magnitude, of risk will be less. As our society becomes more free, there will be more oppor tunities to fail, but we will broaden our opportunities to rise again when we fall-and risk will become less risky! ~ Henry Hazlitt Economic Forecasting: How Good Is It? A professor of one of the physical sciences at a large university re cently wrote me to ask whether "sci entific" prediction, precise and cer tain, is possible in economics. My reply follows: The answer is No. And from the very nature of the science it never will be. The main purpose of economics is not to predict the future, but to learn what policies are likely to improve that future. Sound economists al ready know a good deal about those policies, and have known much of it ever since the appearance of Adam Smith's Wealth of Nations in 1776.