I have come across an interesting author (Frank Knight) in Paper produced by History of Economics Review ((2010 Summer, 52) titled “Theorising Risk and Uncertainty in Social Enquiry: Exploring the Contribution of Frank Knight. Over the next few weeks I will be exploring first hand Knight’s work, this post however, takes advantage of the summarizing done on his work and explores a couple of interesting thoughts’
First, Frank Knight apparently shares (actually stated quite a bit before) my contention that we live primarily in an uncertain like universe. Knight thinks of risk and uncertainty along the concept of probabilities, our understanding of them and oour ability to use them regarding future events. Knight does provide an interesting scale of uncertainty and risk that readers in this subject may find useful:
1. A priori probability: this is where we can derive an event’s probability deductively through mathematics. The probabilities are bound in a closed system universe (two sides of a coin, six sides of a dice cube, fifty two cards in a deck, etc.) Knight considers situations that mirror this circumstance as risk like ones. The imbedded uncertainty in these situations is we do not what the actual outcomes will be beforehand. For example, with a coin, there is a 50/50 chance of heads or tails, yet when we toss the coin reveal times we may get any number of actual heads and tails distribution of results. We may get all tails, two thirds heads, and so on. Knight contends that this form of uncertainty is rarely found in life and business.
2. Statistical probability: this where we tabulate the probabilities through experience (versus mathematical means). Using experience we can infer the probabilities and use this insight to calculate the probability of recurrence. Thus we get the notion of frequencies. One of the key underpinnings to this approach is homogeneity (the similarity of the events being observed and commented on). For example, mortality probabilities. Do we include everyone into one distribution of results? Should we segment by gender, nationality, genetic attributes, and so on? If a group has diversity within its makeup, this will likely call into question the usefulness of the imputed statistical probabilities. We can force an average and standard deviation on any collection of items, but unless they are relatively homogenous, the calculations may have little meaning, merit or utility. many situation in like can be clustered under this category, and there are professions (e.g., actuaries) who work to generate meaningful and useful probability tables.The uncertainty here not only includes that found in the a priori set, but also the underlying diversity of conditions that limit the notion of homogeneity.
3. Estimated probability: What if we can’t estimate the universe of expected outcomes? This is the dilemma of the future when embarking on something new to us. This is the situation of uncertainty in its raw form: something we have not experienced yet, so how do we determine probabilities? Knight (and myself) consider this our overwhelming circumstance of life. The whole process of strategy is that of going into the uncertain future with a game plan. Which means a lot can “probably” (sic) go wrong, be unexpected, and different than we wished for. We cannot use a “calculating approach” to deciding what we want to do. mathematics in its various forms will never be all that helpful.
So are we reduced to irrationality? Are we reduced to being “deer in the headlights? Are we reduced to aimless wandering? Should we just give up on planning as such?
Knight, does not consider it irrational to make choices based on what you know, have a sense of, and hope for. Knight considers this the very field of opportunity, what can go terribly wrong can also go incredibly right (and everything in between). I concur, it is irrational to despair at the fact we do not know everything that is vital to our wellbeing. So what, this has always been the case and will undoubtedly continue to be the case. I have adopted in other posts the notion of the “explorers’ dilemma”: How do we prepare for our journey of discovery? I highly recommend the book: “Into The Unknown, The Leadership Lessons From Lewis and Clark’s Daring westward Expedition” by Jack Uldrich (AMACOM 2004)
As I discovered Knight’s scale of describing risk and uncertainty along the scale of meaningfully usable probabilities I am struck by the parallels and differences between he and Nassim Taleb’s white, grey and black swan analogy. Both appear to acknowledge that pure uncertainty is a state of the inexperienced. Whereas Knight focuses on our ability to use probability analysis to guide us in terms of determining likelihood of outcomes, Taleb also notes that we often do not even envisage the events themselves or properly understand them let alone their likelihood. Knight appears to pay particular attention to outcomes (consequences) likelihood, whereas Taleb is attentive to whether the events are foreseeable (occurrence).
Another intriguing thought for me in Knight’s work is the notion of uncertainty and risk being a human ( or social) matter. I have believed for some time now that uncertainty and risk are things that only exist for sentient beings. Also, in practical terms, we in OD can make a valuable contribution to those we serve in dealing with their uncertainty and risk circumstances by focusing on how their past, current and possible future interaction with others creates, manifests, and shifts their uncertainty and risk circumstances. This is something that risk engineers, financial risk managers, and the like do not pay much attention to in their respective disciplines.
At this juncture, I see that both Knight and Taleb have something useful to offer us in OD and I will explore this contention further in future posts.