The Paradox of Risk

I’ve been thinking about risk recently.

There are things in life that are always attended by some risk.

In fact, depending on whether we go by perceived risk or actual risk, it’s probably fair to say that there are valid perspectives in which everything carries risks. There may be examples where all the possible and varied outcomes of something have no negative connotations for the actor, but this is rare and generally involves things that people don’t think about.

We can compare this to praxeology in economics by assessing these risk-free actions as the equivalent of non-scarce materials which do not enter into an individual’s mental calculations.

Risk, then, can be reduced to two factors: the economic and the psychological. The former applies to risks in the physical world which are the results of human actions, the latter to the perception of risk.

Although access to accurate information causes economic and psychological risk to converge, the latter is a factor of perception. Due to many factors, the human perception of risk is inherently flawed, typically in favor of risk aversion, and psychological risk may exceed economic risk.

Another element of economic risk, however, is that risk can often be calculated on the basis of initial costs. For instance, purchasing an item removes the risk of potential financial ruin (as opposed to, say, borrowing against collateral that might be taken away), though it does not remove the risk of a poor investment of money.

This is not so easily dealt with in psychological risk, which is focused on perceptions. While it is possible for the ignorant or unaware to overlook risks, the tendency in risk assessment in the field of psychology is overestimating as opposed to downplaying potential harms.

Economic Risk

Economic risk is material.

This may seem like it should be intuitive, but for a variety of reasons economic risk is not usually taken into account properly.

The first reason for this is simple: economic risk is estimable in ways that other risk cannot be.

This is not to say that economic risk is able to be measured in a cardinal fashion. It may be associated with something that has a numerical value (e.g. “I am risking sixty dollars on this purchase.”) but the true cost of an economic action always functions in an ordinal fashion.

The reason for this is simple:

It is a misconception that the foundation of economics is money. The foundation of economics is human action.

There is no way for an individual’s economic activities to be condensed solely into a balance book analysis of their fiscal habits, because doing this will ignore the factors that led into their decisions and their perceived values. This includes even money itself, as not all people have an equivalent demand for money.

But this does not mean that it is impossible to make economic assessments of risk.

This is the job of actuaries, who attempt to determine the amount of economic resources that should be retained in case of an emergency and weigh this against the plausible risks.

Risks and Outcomes

If we consider the goal of any action to be the achievement of a desirable outcome (and anything else is playing semantic games unfit for adults, though some toleration should be shown to inquisitive children who seek to expand their understanding through an exploration of set norms), a risk is the outcome of malinvestment.

It is worth noting that malinvestment in this case may not be, per se, the fault of the economic actor. Imperfect information is the nature of the world, and as a result we should expect all actions to carry some risk, regardless of the apparent security or safety of any given course of action.

That is to say that we should not associate a moral judgment with economic risk. Those who seek to moralize should better focus on those who permit vices to impact their actions.

In strictly economic actions, there is no vice. That is not what economics seeks to assess. Further, since economics studies exchange, no coercion can actually enter into economics because the functioning of force in interactions turns an exchange into a single-direction intervention (e.g. robbery or theft) that cannot hold value. That a person may choose different courses of action when threatened with coercion or may take certain actions to respond to uncertainty can be factored into economics, but only as it alters their desires and course of action (e.g. the investment of resources for protection, the reduction in desire to produce goods that go to plunderers and bandits, economic actions that hide wealth).

It is to be noted then that economic risk has three qualities:

  1. It reflects the chance for an action to result in an unexpected and less desirable outcome. Windfalls are not risk.
  2. It reflects the investment of resources and time.
  3. There is a predicted outcome that was the original impetus for action.

It is a mistake to believe that a risk is quantifiable, or reduces the value of an action.

What reduces the value of an action is the outcome being unfulfilled in accordance with the original prediction.

It is possible for a risk to function independently of the desired outcome.

For instance, let us take the case of a man who walks to the store. The desired outcome is shopping at the store. The risks can be manifold.

If the store is closed, the risk is the time the man spent and the desired outcome cannot occur.

However, the man could make it to the store, do his shopping, and return home while picking up a contagious disease.

In this case, there was a risk (perceived or not) of the man getting sick.

In the realm of economic action, this risk does not directly influence the value of the action.

This is where the mistaken belief that criminalizing activity will reduce its practice comes from.

Instead of reducing the value of targeted activity, criminalization creates a risk and seeks to have it known.

The risk may have the desired effect, but only when combined with a sufficient threat of violent deterrence (or feeble agreeability, but those who are agreeable enough to obey the law without an attached risk are usually not the sorts of people whose actions laws seek to restrict).

In any case, we should consider economic risk as distinct from the value of an action. It is a potential cost that may accompany an action, but the two are considered separately.

This does not mean that an actor will never behave as if the outcome value is lowered because of potential risk, but it does mean that risk mitigation can take on its own value in economic spheres (hence insurance as an industry).

On the other hand, psychological risk deals with the internalized information and ideas of an individual, and will therefore consider all the elements of a decision making process as one whole. Psychological risk, however, is even less quantifiable than economic risk. Economic actions can be prioritized in accordance with a hierarchy of values, but psychological actions cannot be.

The Game-Ending Risk

One consideration in economic risk is that any individual is constantly engaging in economic action, not merely engaging in one-off exchanges and then returning to total inactivity.

While this may theoretically apply in contrived circumstances, these contrivances have no bearing in reality and should be dismissed.

The game-ending risk is that which promises the absolute destruction of the economic actor. This can take several forms: death, slavery, imprisonment, debt bondage, and the like.

Bankruptcy laws exist to remove the game-ending risk from economic calculations, but this only applies to those economic activities that are regulated by those laws.

For other activities, whether they are non-fiscal (e.g. skydiving) or unprotected by bankruptcy laws (e.g. college loans), the game-ending risk reflects the idea that a potential action will permanently curtail further economic actions.

Game-ending risks are evaluated according to time preference. Someone with a high time preference will seek to gain the best possible outcome immediately due to future uncertainty (or a dismal outlook for the future), personality traits that lead to a search for instant gratification, or heightened needs for immediate expenditure (e.g. health problems that require medical treatment).

On the other hand, someone with a low time preference will seek to achieve outcomes further out in the future, making sacrifices in the present to achieve a more desirable outcome later.

It is those who exhibit low time preference who avoid game-ending risks, such as those associated with antisocial or dangerous behaviors. This is an advantage of a stable and functioning society, though it negatively correlates with government action (since the majority of economic agents do not control the government, government power can lead to regime uncertainty and an increase in time preference due to the unpredictability of state action).

Opportunity Costs Are Not Risks

One of the differences between economic and psychological risk is this: the fear of missing out that often characterizes the psychological functions that lead into human action is absent in economics.

Economics is concerned with the material management of one’s time and resources. We consider any action that results in the planned outcome successful, at least from the perspective that the plan leads toward desirable action (and is there any other kind of plan?).

The opportunity costs that come alongside any economic action are not risks. They are write-offs from the very start of the action. They impact the initial valuation of action and its outcomes.

While a windfall may cause an opportunity cost to be moot, this is good fortune and not the desired end of an economic activity.

Therefore, when considering risk an economic actor is only going to consider the chances that the action they take leads away from the desired outcome.

Psychological Risk

Psychological risk is associated with the emotional side of people.

This is a simplification, since the emotions and reasoning capabilities of people are both more intertwined and more likely to draw from the same information than people give them credit for.

It is true, however, that rationalization generally seeks to quantify phenomena (whether or not this approach is appropriate is moot, and the quantification is not numerical in the fashion of an empiricist in any case), and emotion generally seeks to qualify stimuli.

The result of both is the psychological disposition toward a given object.

When this disposition is negative, we can call it an aversion, since the psychological actor seeks to avoid the potential object.

We can divide these aversions into two forms: preference and risk.

Someone whose aversion is preference-based will always avoid a particular object. For instance, someone who is afraid of insects will choose to avoid insects wherever doing so does not present greater discomfort in other ways.

Preference is certain. The end is wrapped up with the psychological object being considered. If something violates one’s moral or aesthetic preferences, the thing itself becomes the subject of aversion.

On the other hand, aversion based on risk is a response to stimuli based on speculation.

Risk Aversion

It is worth noting that risk aversion tends to be much more rational than preference aversion, though both can be driven by emotion.

Where preference aversion is accompanied by a statement like “I do not like…” risk aversion is accompanied by a “But this could…”

Therefore, risk aversion is built on the following premise: I will avoid this because of a potential problem.

This makes the psychological risk function in an almost directly antithetical fashion to economic action.

Whereas economic action seeks a desired end, psychological risk aversion avoids an undesirable outcome.

The consequence of this is that we can qualify psychological safety (the avoidance of risk) as an economic good, but not risk-freedom.

Neurosis

It is neurosis and the associated psychological traits and complexes that drive the assessment of psychological risk.

The neurotic focuses on the undesirable, both in the present and the future, drawing on qualia or quanta from past exposures.

The unknown is a distinct phenomena in psychological risk assessments, and can function semi-independently of neurosis (e.g. someone may be neurotic but not apply these neuroses automatically to the unknown, or someone may lack a neurotic focus on the negative aspects of their experiences but not have any desire to encounter novel and unfamiliar psychological territory).

In any case, those who are neurotic and have a low openness to new experiences are going to place a higher value on the avoidance of risk, whereas those who are not will generally be less risk averse.

This is not to say that personality is destiny: people can possess values and quirks that shape their actions in ways that defy simple quantification along axes.

But What is the Psychological End?

We know the economic end, which is to achieve a desired outcome through human action.

But the psychological end is less clearly defined.

It is probably the case that individuals differ sufficiently that a clear statement of the psychological end is unimportant. The great economist Mises would argue that the end of human action is to reduce discomfort, but the psychological does not always manifest in action.

Therefore we come to a problem with psychological risk, which is that it is impossible to point to a psychological end, and even if one were to be found in a particular case it seems unlikely to be universal. Many of the explanations of psychological goals, even those arrived at by the best thinkers humanity has produced, fall flat in application.

This creates a problem, because the truth may be that there is no clear psychological end. At the very least, there may not be a sufficiently clear psychological existence that there is a single end people would pursue; this is the fundamental thesis that the Jungian idea of individuation arrived at. For Jung, people started as disintegrated beings, essentially driven by spirits, and then became a whole individual by arriving at a negotiation of values and discovery of mutual ground between the disparate parts of the psyche.

Risk of the Unknown

The risk of the unknown, then, can present a similar threat to the psychological entity as the game-ending risk can present to the economic entity.

We see this in people who become too paralyzed to act.

In lieu of a clear orientation to guide their action, some people will regress into complete inaction through psychological avoidance. This does not always mean that they cease economic action (since the true cessation of action would be something akin to suicide), but they may instead surrender to ideological possession or seek subjugation beneath someone whose view of reality seems more tenable than their own.

The Paradox of Risk

The paradox of risk is this:

At a certain point, risk becomes unbearable discomfort.

Economic risk that exceeds all action is going to result in actions that are seemingly at odds with economic interests. People who should be saving or investing assets will instead seek to transform them. Time preference shifts are a notable tendency here that indicate an unbearable risk of future harm.

Compare psychological risks, which can create a complete retreat from the proper life of the individual and the disintegration of the mind.

In either of these cases, we wind up with an individual who is distressed beyond the normal rules of the system.

Revolutionary Risk

We might call certain forms of risk revolutionary, because they are both intolerable and able to be traced back to a distinct source.

This is one reason why there is a tangible motive for political factions to treat their opponents fairly and with dignity, because when an individual feels that the opposing faction will essentially oppress and destroy them they have no reason not to interpret the gain in power of that faction as a risk to be met with peremptory violence, because their own destruction may be assured in either case.

Obliterating Risk

The other form of paradoxical risk is obliterating risk, which rises to the same point of distress as revolutionary risk but lacks a clear and overt cause.

In the case of obliterating risk, the only proper solution that can ameliorate the suffering of the afflicted individual is a reframing of goals and values. It may be that there are ways to mitigate this risk (e.g. insurance) or that the proper frame of assessment has not been arrived at by the individual assessing the risk. In any case, the actual response to obliterating risk is inaction to the extent it is possible for the individual that suffers under it to cease action.

Wrapping Up

The lesson to be had from this is that worrying about things can be counter-productive, and that risk should be approached from a position of understanding and mastery.

Economic risks must be mediated from the perspective of cost/benefit analyses. While all outcomes must in the end be ordinal rather than cardinal, as desired outcomes and costs are going to be interpreted through subjective valuation processes, the actuarial process can play a role in determining proper action when risk threatens an endeavor.

Psychological risk is more insidious and often relates to the foundational elements of human perception and personality. The proper approach here can be summed up as a conscious examination of the bearable and unbearable parts of life with an eye to determining the course of action that best removes distress, which places the problems of the psyche in the economic realm of human action.

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