We preach certainty, but uncertainty is trump | Opinion

Economists love market forces. Because if you want to know how scarce goods and services should be distributed among people with infinite needs, bringing supply and demand together in a market is extremely efficient. A price is automatically determined where supply and demand are equal and that’s it.

The perfect market model is very popular among economists. It’s a beauty. Because go figure. If supply and demand are equal, then profit is a redundant concept. After all, as soon as a provider increases its price, it loses all its customers who move to the competitor who does not increase its price. And if someone drops below the equilibrium price, their competitors will do the same, otherwise they will lose their turnover.

In reality this never happens. It may be educationally useful to explain market forces in this way, but it only becomes exciting when you have to drop the assumptions that have to be made for a perfect market in reality one by one. A perfect market can only function in a static society. So stagnant water, no dynamics.

And if something does change, no one enjoys a temporary advantage, because the change applies to everyone and immediately. There is no one who has power in the market above the competitor, because as soon as that would be the case, competitors would appear on the market and the power would disappear. There are many providers. Monopoly does not exist. Access to the market has no obstacles. Consumers and producers have complete insight into the quality of the goods and services offered at any time. It’s like Adam and Eve before the serpent came on the scene.

End of the fairy tale

One hundred years ago, Frank Knight put an end to this fairy tale. He wrote a dissertation on risk, uncertainty and profit. The book is still printed and read and that is necessary because the love for the perfect market runs deep among economists. Our Central Planning Bureau, for example, still works with general equilibrium models, although it always notes that the results are surrounded by uncertainty. But this is always forgotten when using the models.

Knight peels away the model part by part by confronting the assumptions with reality. He mainly does this for the company. He sees that there is indeed imperfect knowledge of the future among producers and consumers. Entrepreneurs take risks and have to deal with uncertainty. Risks can be assessed and can be insured if there are enough entrepreneurs who want to participate in the insurance. This used to be called mutual insurance. Entrepreneurs can also reduce risk by speculating on the stupidity of their customers. They do this through marketing and advertising. The items have always been renewed and improved and you get three for the price of two.

It is different with uncertainty. You cannot estimate uncertainty, otherwise it would no longer be uncertainty. To combat uncertainty, you must dare to judge or just be lucky. According to Knight, this is pre-eminently the task of the entrepreneur. In business, dealing with risks and uncertainty is outsourced. You hire people who you think can assess risks and make sound judgments. And if things turn out wrong, you can always say that your boss made the wrong assessment. That will come to an end one day. That is with the owner of the company, who appoints the director.

Approach risks wisely

The owner is confident that the director can assess risks and deal with uncertainty in a wise manner. If the owner gets this wrong, he will have to suffer and see the value of his company decline. In large companies, the owner is the shareholder and ultimately earns the profit or takes the loss. This model still works, although there are also perverse aspects to it. You often see the director and the shareholder tickling each other. The shareholder rewards the director with an annual income of several million euros and the director rewards the shareholder by purchasing shares from the profit, making them more valuable.

Knight’s legacy still influences the discussion about the quality of economic science. For example, Daniel Kahneman, the winner of the Nobel Prize in economics who died last month, showed that the rational consumer, the homo economicus, does not exist at all. For example, he asks the question: if you like ping pong and you buy a bat plus ball for 1.10 euros and the bat is one euro more expensive than the ball, how much does the ball cost? If you say: 10 cents then you are wrong. I must honestly say that I wrote this problem out in algebra before I understood it. When Kahneman presented his theory to the American Association of Economists, he thought they would be at a loss now that they saw that their models were built on quicksand. None of that. They shrugged and continued to figure out their equilibrium models with college algebra. Science will not let its toy be taken away that easily.

More and more attention

Uncertainty is also receiving increasing attention in organizational theory. For example, Snowden and Boone have outlined a framework within which leaders make their decisions. The frame contains four fields. In the first is everything easy . Consider, for example, payroll administration. There is little that can go wrong. What lurks is complacency. In the second field it is complicated . There are several good answers and what you need to do is analyze carefully and develop a best practice. It is wise to bring experts from different disciplines to the table. The danger is that the experts will argue and a solution will not be found in time.

In the third field it is complex. You don’t remember. The unknown is truly unknown. Predictability is not possible. Keep trying carefully, take the temperature and only then answer. Experiment and accept that you can fail and still move on. Finally, there is the chaos. Here the unknown not only reigns, but it is also unknowable. Turbulence is the order of the day and leaders must dare to act commandingly, guided by intuition. If they succeed, that’s a bonus, but it’s wise to keep a shadow team on hand just in case. A successful leader runs the risk of having his ego inflated.

It seems that our society is in the field of complexity, but citizens think that it is all simple. It would be useful if the concept of ‘responsibility’ was polished again and dealing with uncertainty became part of the way of life. Too often, all the problems are passed on to politicians and they throw money at them. The welfare state becomes a compensation society. For example, if you think the minimum wage is too low, why don’t you become a member of the union that arranges it for you in the collective labor agreement? That seems better than taking out your anger on social media and helping Wilders into the saddle.

Gerrit de Jong is an economist