§8. The Influence of Risk

We come finally to the element of risk. Future income is always subject to some uncertainty, and this uncertainty must naturally have an influence on the rate of time preference, Edition: current; Page: [77] or degree of impatience, of its possessor. It is to be remembered that the degree of impatience is the percentage preference for $1 certain of immediate income, over $1, also certain, of income of one year hence, even if all the income except that dollar be uncertain. The influence of risk on time preference, therefore, means the influence of uncertainties in the anticipated income of an individual upon his relative valuation of present and future increments of income, both increments being certain.

The manner in which risk operates upon time preference will differ, among other things, according to the particular periods in the future to which the risk applies. If, as is very common, the possessor of income regards his immediately future income as fairly well assured, but fears for the safety or certainty of his income in a more remote period, he may be aroused to a high appreciation of the needs of that remote future and hence may feel forced to save out of his present relatively certain abundance in order to supplement his relatively uncertain income later on. He is likely to have a low degree of impatience for a certain dollar of immediate income as compared with a certain dollar added to a remoter uncertain income.

Such a type of income is, in fact, not uncommon. The remote future is usually less known than the immediate future, a fact which of itself means risk or uncertainty. The chance of disease, accident, disability, or death is always to be reckoned with; but under ordinary circumstances this risk is greater in the remote future than in the immediate future. As a result, uncertainty has a tendency to keep impatience down. This tendency is expressed in the phrase "to lay up for a rainy day." The greater the risk of rainy days in the future, the greater the Edition: current; Page: [78] impulse to provide for them at the expense of the present.

But sometimes the relative uncertainty is reversed, and immediate income is subject to higher risk than remote income. Such is the case in the midst of a war, in a strike, or other misfortune, believed to be temporary. Such is also the case when an individual is assured a permanent position with a salary after a certain date, but, in the meantime, must obtain a precarious subsistence. In these cases the effect of the risk element is to enhance the estimation in which immediate income is held.

Again, the risk, instead of applying especially to remote periods of time or especially to immediate periods, may apply to all periods alike. Such a general risk largely explains why salaries and wages, being relatively assured, are generally lower than the average earnings of those who take the risks incident to being their own employers. It also explains why the bondholder is content with a lower average return than the stockholder. The bond-holder chooses fixed and certain income rather than a variable and uncertain one, even if the latter is, on the average, larger. In short, a risky income, if the risk applies evenly to all parts of the income stream, is equivalent to a low income. And, since a low income, as we have seen, tends to create a high impatience, risk, if distributed in time, uniformly or fairly so, tends to raise impatience.

It follows, then, that risk tends in some cases to increase and in others to decrease impatience, according to the time incidence of the risk. But there is a common principle in all these cases. Whether the result is a high or a low time preference, the primary fact is that the risk of losing the income in a particular period of time operates, in the eyes of most people, as a virtual impoverishment Edition: current; Page: [79] of the income in that period, and hence increases the estimation in which a unit of certain income in that particular period is held. If that period is a remote one, the risk to which it is subject makes for a high regard for remote income; if it is the present (immediate future), the risk makes for a high regard for immediate income; if the risk applies to all periods of time alike, it acts as a virtual decrease of income all along the line.

There are, however, exceptional individuals of the gambler type in whom caution is absent or perverted. Upon these, risk will have quite the opposite effects. Some persons who like to take great speculative chances are likely to treat the future as though it were especially well endowed, and are willing to sacrifice a large amount of their exaggerated expectations for the sake of a relatively small addition to their present income. In other words, they will have a high degree of impatience. The same individuals, if receiving an income which is risky for all periods of time alike, might, contrary to the rule, have, as a result, a low instead of a high degree of impatience.

The income to which risk applies may be, of course, either the income from articles of capital external to man or the income from man himself, considered as an income producer. In the latter case, often called earned income, the risk of losing the income is the risk of death or invalidism. This risk—the uncertainty as to human life, health and income producing power—is somewhat different from the uncertainty of income flowing from objective capital: for the cessation of life not only causes a cessation of the income produced by the dying human machine, but also a cessation of the enjoyment of all income whatsoever—or rather a transfer of the enjoyment Edition: current; Page: [80] to posterity of any income continuing after death. This is because the individual is in the double capacity of being at once a producer and a consumer.

The effect of risk, therefore, is manifold, according to the degree and range of application of risk to various periods of times. It also depends on whether or not the risk relates to the continuation of life; and if so, according to whether or not the individual's interest in the future extends beyond his own lifetime. The manner in which these various tendencies operate upon the rate of interest will be discussed in Chapter IX.