Amid an article about the GM bankruptcy, Mark Ambinder (political correspondent for the Atlantic Magazine) has the following offhand comment:
Purists — and virtually every academic economist one happens to encounter — wonder what happened to the once inviolate principle of rewarding risk-takers.
On a literal level, I don’t think that’s correct: the idea is that risk-takers can win big if they win, but if they lose, they lose: that’s what “risk” is all about. I don’t think anybody (except the risk-takers themselves, along with their friends and families) think that risk-takers should be rewarded when their bets lose.
But that’s all obvious and fits in with all the moral-hazard, perverse-incentives things we’ve been hearing about for awhile.
Why I’m going on about this
What interests me is the centrality of “risk” in the world of economics now. Until being pointed to the article linked to above, I had never heard of the “once inviolate principle of rewarding risk-takers.” Then again, it’s been almost 30 years since I’ve taken an economics class. In that class, the idea of “risk” wasn’t mentioned at all, I think. We learned about about supply and
demand, inflation and unemployment, money, investment, the stock market, etc. But the whole “risk” thing didn’t come up.
Since then I’ve read enough to know that academic economists have been talking about
risk for awhile, but I don’t think it was in the forefront of discussion. For example, I don’t think a magazine columnist 30 years ago would’ve written about the inviolate principle of rewarding risk-takers, or anything of the sort. Things have changed–a lot.
There is no 'inviolate principle of rewarding risk-takers' in academic economics. There is the 'incentives matter' outlook, but that's about it. I have no idea who Ambinder has been talking to, but I suspect he's not been understanding them if they are academics.
The Economics of Risk and Time by
Christian Gollier is nice write-up of how economic theorists think about risk.
Wow, just astonishing.
The post linked to conflates the study of risk, which is old, with a made-up political term. Risk management became important with Black-Scholes and then securitization models but doesn't it trace back to coin-flipping?
The concept he states is a direct reversal of the real meaning of risk, which is that if you win you are paid a reward commensurate with the gamble you took – as in bet 24 in roulette and if it hits you get back 35 for your 1 but only 2 to 1 if you bet black or red. This is why I say the comment is political; he's labeling this thing and using that straw thing to characterize the government and, in particular, Obama.
[Speaking of coin flips, like many people, I sometimes imagine living in the past and one thing I've hit on is that I'd love to go back and gamble. Why? Because almost no one understood odds, which is how people lost (and a few made) huge fortunes. If you remember Back to the Future II, the future is changed by a sports book from the future that lists winners. But in the real world, you wouldn't need that book; you'd merely have to understand the basic rules of probability in a world where they weren't known. ]
BTW, he distorts one point: the bondholders were equal, not senior in priority to the union pension plan. He is also apparently ignorant of the workings of bankruptcy. Priority matters but the reorg plan matters a lot and it all becomes a negotiation. Creditors may try to force a liquidation – or a dismemberment – but these bondholders aren't bringing anything to the party: no financing, no commitment to fund operations, nothing. The government, on the other hand, is providing something like $50B in financing, which means they are bringing the cash to the table. The bondholders' actual leverage is the sheer amount of their debt; in the usual case, something is negotiated, meaning bonds are paid in part, part converted to equity, part carried over to the new company. And that's what happened here. The bondholders got warrants to buy 15% more plus the new company will carry some of the existing debt. This is classic bankruptcy with the government taking over the role a consortium of banks would normally play. The reasons for that are less political than economic. (Sorry for the long comment and sorry if I was startlingly obvious.)
I suspect that you did encounter mention of "risk" in your economics class 30 years ago.
I think you encountered the notion of long-run profits tending to zero in a market/industry, with a proviso that the profits under discussion meant "economic profits" and that "economic profits" were those above some amount that included a return that compensated for risk-taking.
All quite easily glossed over!
Allow me to translate from Ambinderish to English.
Purists [Supply-siders like Jack Kemp] — and virtually every academic economist one happens to encounter [Fellows at the American Enterprise Institute] — wonder what happened to the once inviolate principle of rewarding risk-takers [protecting Capital at the expense of Labor].
William: I don't think Ambinder would put it that way! But it's hard to evaluate his statement without knowing who were the economists with whom he talked.
Brent: You might very well be right. But I don't remember it that way. I remember we did talk about profits and where they came from, but I don't recall anything about risk. I remember being told that profit comes from being able to sell something for more than it costs to make. I'm also pretty sure we talked about monopoly and competition. But risk-taking, maybe not.