THE Age of Uncertainty is a book and BBC series by the late Harvard economist
John Kenneth Galbraith, produced in 1977, about how we have moved from the age
of certainty in 19th century economic thought to a present that is full of unknowns.
I still remember asking my economics professor what he thought of Galbraith, one of
the most widely read economists and social commentator of his time. His answer was
that Galbraith’s version of economics was too eclectic and wide-ranging. It was not
where mainstream economics – pumped up by the promise of quantitative models
and mathematics – was going.
Forty years later, it is likely that Galbraith’s vision of the future was more prescient
than that of Milton Friedman, the leading light of free market economics – which
promised more than it could deliver. The utopia of free markets, where rational man
would deliver the most efficient public good from individual greed turned out to be
exactly the opposite – the greatest social inequities with grave uncertainties of the
future. Galbraith said, “wealth is the relentless enemy of understanding”. Perhaps he
meant that poverty and necessity was the driver of change, if not of revolution.
The economics profession was always slightly confused over the difference between
risk and uncertainty, as if the former included the latter. The economist Frank Knight
(they don’t make economists like that anymore) clarified the difference as follows –
risk is measurable and uncertainty is not. Quantitative economists then defined risk
as measurable volatility – the amount that a variable like price fluctuated around its
historical average.
The bell-shaped statistical curve that forms the conventional risk model used widely
in economics assumes that there is 95% probability that fluctuations of price would be
two standard deviations from the average or mean.
For non-technically minded, a standard deviation is a measure of the variance or
dispersion around the mean, meaning that a “normal” fluctuation would be less than
two; so if the standard deviation is say 5%, we would not expect more than 10% price
fluctuation 95% of the time.
Events like Brexit shock us because the event gave rise to huge uncertainties over
the future. Most experts did not expect Brexit – the variance was more than the
normal. It was a reversal of a British decision to join the European Union, a five or
more standard deviation event – in which the decision is a 180 degree turn. The
conventional risk management models, which are essentially linear models that say
that going forward or sequentially, the projected risk is up or down, simply did not
factor in a reversal of decision.
In other words, we have moved from an age of risk to an age of uncertainty – where
we are dealing with unknown unknowns.
There are of course different categories of unknowns – known unknowns (things that
we know that we do not know), calculable unknowns (which we can estimate or know
something about through Big Data) and the last, we simply do not know what we may
never know.
Big Data is the fashionable phrase for churning lots of data to find out where there
are correlations. The cost of big computing power is coming down but you would still
have to have big databases to access that information or prediction. Most individuals
like you and me would simply have to use our instincts or rely on experts to make that
prediction or decision. Brexit told us that many experts are simply wrong. Experts are
those who can convincingly explain why they are wrong, but they may not be better in
predicting the future than monkeys throwing darts.
Five factors
There are five current factors that add up to considerable uncertainty – geopolitics,
climate change, technology, unconventional monetary policy and creative destruction.
First, Brexit and the Turkish coup are geo-political events that change the course of
history. In its latest forecasts on the world economy, the IMF has called Brexit “the
spanner in the works” that may slow growth further. But Brexit was a decision made
because the British are concerned more about immigration than nickels and dimes
from Brussels. This is connected to the second factor, climate change.
Global warming is the second major unknown, because we are already feeling the
impact of warmer weather, unpredictable storms and droughts. Historically, dynastic
collapses have been associated with major climate change, such as the droughts that
caused the disappearance of the Angkor Wat and Mayan cultures. Iraq, Afghanistan,
Syria, Sudan and all are failing states because they are water-stressed. If North
Africa and the Middle East continue to face major water-stress and social upheaval,
expect more than 1 million refugees to flood northwards to Europe where it is cooller
and welfare benefits are better.
The third disruptor is technology, which brings wondrous new inventions like bio-
technology, Internet and robotics, but also concerns such as loss of jobs and genetic
accidents.
Fourthly, unconventional monetary policy has already breached the theoretical
boundaries of negative interest rates, where no one, least of all the central bankers
that push on this piece of string, fully appreciate how negative interest rates is
destroying the business model of finance, from banks to asset managers.
Last but not least, the Austrian economist Schumpeter lauded innovation and
entrepreneurship as the engine of capitalism, through what he called creative
destruction. We all support innovation, but change always bring about losses to the
status quo. Technology disrupts traditional industries, and those disappearing
industries will create loss in jobs, large non-performing loans and assets that will
have no value.
Change is not always a zero-sum game, where one person’s gain is another’s loss. It
is good when it is a win-win game; but with lack of leadership, it can easily deteriorate
into a lose-lose game. That is the scary side of unknown unknowns.
I shall elaborate on how ancient Asians coped with change in the next article.
Tan Sri Andrew Sheng writes on global issues from an Asian perspective.
A version of this article appeared in The Star Online, 23 July 2016
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