A century ago, Frank Knight wrote a book that put uncertainty in its rightful place at the heart of economics and entrepreneurship. I love that his last name was a homonym of “night,” when objects are hidden by darkness and uncertainty reigns.
Knight’s thinking is as relevant now as it was in 1921, when “Risk, Uncertainty and Profit” was published. We still need tools for coping with uncertainty. Knight’s perspective can guide us to a middle course between trying to avoid uncertainty entirely, which is impossible, and plunging headlong into the darkness, which is reckless.
Knight has been forgotten or misconstrued repeatedly over the past century. A new book by the scholar Amar Bhidé brings back his original insights and dares to try to improve upon them — mostly by extending them into realms that Knight didn’t consider, such as the persuasive techniques that entrepreneurs use to overcome the uncertainty felt by investors, customers and partners. (The cherry-red Tesla Roadster that Elon Musk launched into space in 2018 makes an appearance.)
Last week I interviewed Bhidé about his book, “Uncertainty and Enterprise: Venturing Beyond the Known.” Interviewing him about Knight was like asking Ahab about the white whale in “Moby-Dick,” since Bhidé has been obsessing about Knight since around 1990. At the time, Bhidé was teaching at Harvard Business School and then-dean John McArthur sent him a copy of Knight’s most famous book.
Knight drew a contrast between risk and uncertainty. Risk, he wrote, applies to situations where the probability of an outcome can be measured and therefore insured against. An example is the chance of drawing the queen of hearts from a deck of cards: 1 in 52. Knight applied “uncertainty” to all other unknowns, although he, like Bhidé, was mainly interested in business decisions. Profit, in Knight’s formulation, was the compensation that businesses earned for putting up with uninsurable uncertainty.
“Knightian uncertainty” is a buzz phrase in economics today. Knight is lionized in “Radical Uncertainty: Decision-Making Beyond the Numbers,” a 2020 book by John Kay and Mervyn King. He appeared again this year in the British publication of David Spiegelhalter’s “The Art of Uncertainty: How to Navigate Chance, Ignorance, Risk and Luck.”
But the mainstream of economics name-checks Knight while rejecting most of his heterodox ideas. Bhidé calls him “the spark that did not ignite.”
“This has been my quarrel, my singular lack of success in influencing my economist friends” about Knight’s importance, Bhidé told me. “They don’t object to my facts. They don’t even object to my interpretation. They just don’t think this is what they should be working on.”
Many academics have the attitude that “if things cannot be analyzed statistically, they’re not worth analyzing,” Bhidé told me. Approaches such as Knight’s that are out of the mainstream “are excluded from the conversation,” he said. “I’m definitely trying to have them included in the conversation.”
Knight was an outsider from the start. His father took him out of school at age 12 to work on the family farm in Illinois. He read by propping up books on a horse-drawn plow. He returned to school intermittently from age 18 on. “Risk, Uncertainty and Profit” was an expansion of the doctoral thesis he wrote at Cornell. At the University of Chicago, he founded what became known as the Chicago School of economic thinking. But he was no charismatic leader — “skeptical,” “cantankerous” and an “incomprehensible lecturer,” Bhidé writes.
Milton Friedman, who was Knight’s doctoral student, ended up rejecting Knight’s distinction between risk, where probability is measurable, and uncertainty, where it isn’t. Friedman took the Chicago School in a different direction. He and other founders of today’s economic orthodoxy based their economic theories on the assumption that people always behave as if probability is measurable: that people effectively lay odds on events all the time, or at least behave as if they’re making such bets.
The problem with focusing on problems that are amenable to statistical analysis is that it ignores the particular and the specific, where uncertainty lurks. “Even in macro problems, disregarding specific circumstance leads to unverifiable claims — such as that money supply affects prices with ‘long and variable lags’ — that smack of astrological prediction,” Bhidé wrote to me in an email.
While Friedman and his followers reduced uncertainty to “mechanistic calculation,” Bhidé writes in the book, other scholars banished it to “the mystical world of unknown unknowns.” In either case, he writes, mainstream economics “hides from uncertainty.”
Bhidé makes a case that Herbert Simon, a Nobel laureate, came closer than others to upholding the Knightian tradition. Simon is best known today for his coinage of “satisficing,” which is coping with uncertainty efficiently by finding a solution that is satisfactory even if imperfect. Simon, alas, lost influence despite his laurels. “My economist friends have long since given up on me, consigning me to psychology or some other distant wasteland,” he wrote in 1991.
Bhidé, who was born and raised in India, earned master’s and doctoral degrees in business administration from Harvard Business School before teaching entrepreneurship and business at Harvard, Tufts, Chicago and Columbia. He’s now a professor of health policy and management at Columbia University Irving Medical Center.
The entrepreneur who battles with uncertainty is the central character in both Bhidé’s work and Knight’s. Bhidé argues that while Friedman lauded entrepreneurs in his book and television series, “Free to Choose,” he made no room for them in his scholarly writing, which minimizes the role of uncertainty. William Baumol, another economist, once joked contra Friedman and his followers that without entrepreneurship, economic theory was a “Hamlet” without the prince of Denmark.
Entrepreneurs don’t care about the statistical likelihood of a business like theirs failing, Bhidé told me; they care about their own businesses. “They make their judgments through some combination of imagination and the facts of the matter at hand,” he added.
The decision-making routines that entrepreneurs use “resemble operas rather than algebraic equations with well-specified numerical inputs and outputs,” Bhidé writes. Their routines aren’t simple. “Like the scores, librettos, choreography, and stage designs of operas,” he writes, “routines can have intricate, interrelated components.”
Large corporations behave differently from entrepreneurs. They have the wherewithal for great projects that entrepreneurs can’t afford, but they limit their risks through bureaucratic controls and by avoiding “unsettled areas or great novelty,” Bhidé writes.
Large corporations get in trouble when they’re either frozen by fear or are overly risk-loving, he told me. The latter mistake, he said, can be “ceding so much authority to some savant or someone who happens to occupy the position of C.E.O.” Before I could ask, he added, “I’m not naming names.”
I mentioned Musk’s Roadster as the sort of attention-getting gambit that impresses Bhidé, even though Knight probably would have frowned upon it. Another way Bhidé tries to modernize Knight is by adding a process and standards of evidence to justify one-off choices. They take into account the stakes (say, criminal trials versus choice of toothpaste), the novelty and complexity of the cases.
Uncertainty by its very nature resists clean, simple answers. Knight wrote in 1949, “So, the final word should be, ‘beware of absolutes.’” He added that “the ultimate besetting sin of the ‘intellectuals’ is oversimplification.”
Knight’s warning against oversimplification sounds like a quip from H.L. Mencken that Bhidé cites: “For every complex problem there is an answer that is clear, simple and wrong.”
Clear, simple and wrong is a good description of economic theories that exclude uncertainty. “If I can merely put uncertainty back into the conversation, and say it’s at least as important as incentives,” Bhidé told me, “I would consider that a win.”
Elsewhere: Fewer Turkeys This Thanksgiving
The United States will raise about 205 million turkeys this year, down 6 percent from last year and down about 17 percent from 2017, according to the National Agricultural Statistics Service. Because demand for turkey has also fallen, the price is down 6 percent this year from 2023, to about $1.60 a pound, the American Farm Bureau says. Sweet potatoes are much cheaper this year, but dinner rolls and cubed stuffing mix are up.
Quote of the Day
“Adam Smith’s invisible hand — the idea that free markets lead to efficiency as if guided by unseen forces — is invisible, at least in part, because it is not there.”
— Joseph Stiglitz, “There Is No Invisible Hand,” The Guardian (Dec. 20, 2002)
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