Risk Management Is Broken in the Modern World… Except When It Isn’t

This is a reflection post after having just finished Part 2 of the book “The Rise and Fall of American Growth”. Out of the sectors of the economy this part discusses, the most important sector for current policy decisions is healthcare. Productivity growth has gone starkly negative in terms of the overall picture — we continue to spend more of our incomes on care while life expectancy and other whole-life metrics have stalled. Administrative costs are a policy component that needs to be addressed, but I found another component to be more far-reaching and interesting. The author claimed that our risk management has become so overly precautionary that penicillin (and other drugs that are critical for modern life) could not have been invented within the current regulatory climate.

My mind was swamped with memories of the history of civilian nuclear power while reading this material. Both new drug trials and nuclear power are cases that fit the narrative that we have become overly risk-adverse. It would be easy to paint with a wide brush and presume that a large fraction of the decline in growth can be explained by similarly wrongheaded regulations. However, we could not to hope to demonstrate this with economic numbers, and it’s probably an incorrect presumption.

While energy and healthcare might be examples of overly-protective regulation, I think the author’s case-in-point was a uniquely powerful argument. Because of its effectiveness, I want to recount it here.

Air travel has become progressively more and more miserable over the years, and particularly after 9/11. From the very outset, I think that very few people saw the security checkpoints (and later on, millimeter wave scanner) as something that was worth the cost to society. The problem with correcting the over-regulation starts with the fact that those who bear the cost are not those who bear the risk. The second part where our governance goes wrong is where the decision-makers follow the CYA philosophy to its destructive endgame.

With all the accumulating security measures, we lost sight of what it was that we wanted to prevent. The only very serious issue that 9/11 attacks exploited was the fact that cockpit doors were not locked and reinforced (as argued in Dr. Gordon’s book). Of all the post-9/11 changes, this was one that could be implemented with the least impact to the traveler, and done at the lowest cost. But instead of stoping at some reasonable level of new measures with this change as the cornerstone, our leaders were overwhelmed with the need to feel like they were doing something, resulting in an entirely new industry organized the task of economically worthless security theatre.

Precaution Alone Fails to Explain Our Behavior

When people casually talk about this topic, I think they default to a worldview of “back in the day, we took greater risks, so we had more growth.” The above examples argue that point. But that’s clearly wrong.

Our global economy today is not purged clean of risk. There is an enormous amount of risk that we accept. Even though we can only imagine allowing 1 or 2 members of the public to die from environmental radiation pollution from nuclear plants (if even that), we unthinkingly allow preventable deaths from other sources. Economic inequality, in itself, poses a litany of hardships on the working poor that cary very significant risks to them, and we have no plans to change our economic trajectory because of that. We also grant the individual permission to take risks on their own (although this might be diminishing, considering the precedent of the individual health care mandate). On top of all that, we still keep a nuclear arsenal around which is capable of fast retaliation, posing a very major risk to the globe which, in 2017, is a risk that could be eliminated if the political will existed. Indeed, the political will to eliminate many risks is woefully insufficient to do anything about them.

Climate change is probably the worst preventable risk that we know of on the macroeconomic scale that we continue to indulge in. The unknown risks from climate change are so great that modern society actually holds a candle to the reckless abandon of risks of the early-industrial and pre-industrial world. It used to be that a city could burn to the ground if sufficient dry conditions persisted for long enough. Today, we are facing the destruction of many low-lying cities due to the effects of climate change. Still, we accept that risk and continue the activities that are causing climate change.

Recently with new tech trends, I have found that I can’t even predict what risks we will and will not accept. Consider several cases:

  • Lehmann Brothers’ collapse was a risk we decided to take, but not AIG
  • 23andme received regulatory backlash sufficient for them to halt operations, just for showing users a dashboard that used health information crawled from academic research
  • Uber / Lyft and others outright broke the rules that taxi regulating organizations impose in many cities, and they pretty much got away with it
  • AirBNB broke a ton of hoteling rules, and wound up capitulating or compromising, but not before they established their market position

There is no rhyme or reason to the ultimate decisions in these cases, and they all deal with risk-taking that is in the public interest to limit. So honestly, what is going on?

Note that in some of these cases, our risk tolerance (sometimes taking a blind eye to violations of the law) is the very thing that allows progress in a new tech to happen. Other times, economic growth is directly reduced by laws intended to limit risk to the public. Yes, the author’s observation holds true, but it does not always hold true.

Unequally Distributed Risk Allowances

I strained to think of a phrase that I think describes the state-of-affairs that we are in. How can I describe the simultaneous existence of extraordinarily risk-adverse decisions of public interest while at the same time, explain borderline ignorance of risk in other cases? Risk is still meaningful weighed as a tradeoff, and so, activities consume some amount of risk allowance, as permitted by society. My core observation is that we have vastly disproportionate and unfair — unequal — risk allowances based on the character of the economic activity and who is proposing to take those risks.

As such, those examples where new innovations are allowed to enter the marketplace in spite of imperfect risk abatement should be compared to a broken clock that is right 2 times each day.

The criteria we use to allow and prohibit risk-taking actions can be summed up in one dirty word — politics. I believe that culture is a much smaller part of the picture. It is our politics that will allow for more or less growth, limiting the discussion to the part of economic growth which is sensitive to the precautionary principle.

Obligatory analytical writing, online participation account for Medium. Engineering, software, books, space, constant daydreaming.

Obligatory analytical writing, online participation account for Medium. Engineering, software, books, space, constant daydreaming.