Knowledge, Ignorance, and Spectacles

EconTalk Extra
by Amy Willis
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Greg Ip on Foolproof... Josh Luber on Sneakers, Sneake...

In this week's episode, EconTalk host Russ Roberts chats with Greg Ip of the Wall Street Journal about his new book, Foolproof.

How do people formulate their attitudes toward risk? How do people respond to policies that try to insulate them from risk? How should policymakers take these responses into account? These questions and more are highlights from the conversation. Now let's continue that conversation here...We love to hear from you.

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1. In this recent Econlib column, Arnold Kling explores Ip's distinction between two philosophies for handling risk, those of the "engineers" and the "ecologists." Which style is better for dealing with risk or is it a matter of the context and setting for the risk?

2. Ip argues that attempts to reduce risk often lead to riskier behavior. Is there a difference when policies to reduce risk come from the public sector vs. private decisions?

3. How did the FDIC, in trying to safeguard people's savings, design a system that is inherently fragile? Were some of the inevitable consequences in fact foreseeable? How does deposit insurance illustrate the sort of "systemic risk" that Ip argues can also be illustrated by the US Forest Service's forest fire policy?

4. Roberts and Ip discuss the current controversy over concussions in the NFL. In your opinion, as the NFL adequately addressed these concerns? Related, Ip mentions the role of spectacle in football (and other sports), arguing that this is a reflection of societal expectations about and tolerance about risk. What do you think would have to transpire to alter such macro level attitudes?

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COMMENTS (3 to date)
Daniel Barkalow writes:

From what I heard, the FDIC didn't design a system that was inherently fragile (at least, not since the 80s); the FDIC designed a system that absorbed the failures of a large number of member organizations without the FDIC running out of money and without major runs on the member organizations' insured deposits. The problem Ip raised was that the FDIC's system was so dull (in terms of limits on interest offers and insurance premiums) that a lot of money wasn't there, and it was the money that wasn't there that had the crisis.

I think a lot of why main street's impact was focused on unemployment and foreclosure, rather than losing savings, was that it the FDIC did fine at insuring deposits, and it didn't matter if your bank was Citibank (bailed out), Washington Mutual (failed), Main Street Bank (small bank, failed), Eastern Bank (small bank, did fine), Citizens Bank (did fine), or even MagnetBank (small bank, liquidated and depositors paid back directly). At least in this area, people were able to pick an option that was predictable, at the cost of that option definitely not paying well. And, of course, the ability for people to specialize depends on them not having to have every possible life skill, such as being able to judge the solvency of financial institutions.

I think consumer banking may be an example of a financial version of what the Forest Service's fire policy should be: "Stuff burns down sometimes; sucks about your yard, but at least we got you to make your house out of stone, and nothing left by last year's fire burns hot enough to destroy it." For that matter, the FDIC practically does the equivalent of setting fires to burn dry brush that just happens not to have been hit by lightning yet.

The real issue, in my view, is that businesses end up relying on the non-boring financial markets, and that people keep getting the idea that financial markets can be simultaneously lucrative and safe.

Eugene Kernes writes:

2. In the book 'Free to Choose', Friedman makes a good point about risk. Friedman mentions that if government takes risk and something goes wrong, everyone bares the cost. If a private institution takes risk and something goes wrong, the private institution and those that paid for the product pay the cost but everyone else gets benefits as they now know what is wrong. It is the diffusion of knowledge that makes up Hayek's work. Based on many of Sowell's books, insurance reduces risk when it is highly diversified. Policies taken by the government simply transfer the risk as they affect everyone, while those in the private sector reduce risk better as they can take and try various risk reduction measures.

SaveyourSelf writes:

Diversification -- The simplest, least expensive, most effective way to reduce risk -- is not quite as simple as I first thought.

  • Perspective #1: Engineering approach - Diversification through compartmentalization. Strategy: Invest in three independent shipping companies. If one is raided by pirates, the other two may still turn a profit.
  • Perspective #2: Complex system approach – Diversification through diversity. Strategy: Invest in a shipping company, a pirate company, and an over-land trading company. That way, a shock to any one investment makes all the others more profitable.
1. I believe the ‘complex system’ [ecologist] approach is superior to the engineering approach for several reasons. First, shocks that harm one part of an ecosystem inevitably benefits others. I don’t think many engineered systems can make that claim. Second, engineered systems have a vector. They are designed to handle problems from a particular direction in a particular way and often do not behave appropriately when problems come from an unexpected route or source. Complex systems, on the other hand, have many vectors moving in different directions simultaneously, which makes them more optimal for dealing with shocks whose nature and origin are unknowable in advance (which is basically the definition of a shock).
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