DRI-312 for week of 8-18-13: Understanding Risk, Benefit and Safety

An Access Advertising EconBrief:

Understanding Risk, Benefit and Safety

The mainstream press has propagated an informal historical narrative of safety in America. Prior to the Progressive era and the advent of muckraking journalism, the public lay at the mercy of rapacious businessmen who knowingly produced unsafe products and unwholesome foods in order to maximize their personal wealth. Thanks to the unselfish labors of investigating journalists and the subsequent creation of government regulatory agencies, products and foods became safe for the first time.

Now regulators and the press fight a never-ending battle for safety against the forces of greedy capitalism. Alas, there are so many industries and goods to regulate and so little time and money in the federal budget with which to do it.

In order to appreciate the full falsity of this doctrine, we must grasp the economic meaning of concepts like risk, benefit and safety. A good route to this goal lies through our own inner sense of the logic of human behavior.

A Reductio Ad Absurdum

To highlight the concepts of risk, benefit and safety, consider the following example. It is a reductio ad absurdum – an example “reduced to absurdity” in order to eliminate extraneous considerations and shine a spotlight on a few insights.

Assume you have only one day left to live – exactly twenty-four hours. You are aware of this. You are also aware that your death will be instantaneous and painless and your vitality, faculties and awareness will remain unimpaired up to your last second of consciousness. How will this affect your behavior?

A little thought should convince you that the effect will be profound. You have only one day left to wring whatever excitement, enjoyment and satisfaction you can from life. Will that day be business as usual, awakening at the normal time and departing to work at your job? Unless you work at one of the world’s most stimulating and fulfilling jobs, the last thing you will want is to spend your final day on Earth at work.

Instead, you will devote your time to the most intense and meaningful pleasures. These may be physical or mental, aesthetic or gastronomic, boisterous or sedate. The word “pleasure” inevitably evokes the notion of hedonism in some people, but this need not apply here. The pleasures you seek during your last day may be sensual but they may just as easily be as cerebral as reading a book or as contemplative as observing a sunset. Your personal selections from the vast menu of choice will be highly subjective, in the sense that my choices might very well differ drastically from yours. In spite of this, though, the example affords highly useful insights about economics – particularly the concepts of risk, benefit and safety.

Economic Benefit

The first conclusion to emerge from our artificial but enlightening example relates to the nature of economic benefit. In recent decades, a Martian studying Earth by scanning its news media transmissions and publications might well conclude that the benefit of human existence derives from work. After all, politicians and commentators yammer endlessly about the glories of, and necessity for, “jobs, jobs, jobs.” Taking this preoccupation at face value implies that work, in and of itself, is what makes life worthwhile. The obiter dicta of the rich and famous, who recklessly profess such heartfelt love for their profession that they would practice it for nothing, reinforce this impression.

Our example, though, shatters this shibboleth. Economic value inheres not in work but rather in the things that work produces, which produce pleasure and satisfaction when consumed. It is certainly possible to love one’s work, but it is not coincidence that the people who love it the most are the ones most highly compensated for it; their earnings can purchase the most satisfaction and pleasure. It is a famous truism that nobody’s deathbed reflections are mostly regrets at not spending more time at the office.

Risk

Ever since the pathbreaking work of economist Frank Knight some ninety years ago, economists have defined risk as mathematically expressed variance of possible future outcomes. Uncertainty, the first cousin of risk, applies when the future outcomes vary in ways not susceptible to mathematical expression. For our purposes, however, we will view risk colloquially, as the possibility of unfavorable future outcomes.

Again, it should be obvious that the prospect of death in twenty-four hours’ time will radically affect your attitude toward risk and benefit. You are out to grab all the gusto you can get in the day you have left. From experience, we realize that the pursuit of pleasure can involve some element of risk. For example, the most hair-raising rollercoaster ride may well provoke the most pleasurable response. But it may also produce nausea, vertigo and unsteadiness. There is even the risk of injury or death if the mechanism malfunctions or you somehow are thrown from the ride.

If you are the kind of person who enjoys rollercoasters, you will be undeterred by their risk in our special case. You are certainly not going to pass up this big thrill for fear of a one-in-a-hundred-million chance of death – you’re going to be dead tomorrow anyway! On the other hand, you might well refuse to ride the coaster with your safety belt unbuckled for the first twenty-three hours of your last day. You don’t want to take foolish risks and waste most of your last day. But you might well reverse that decision during your final hour, especially if you always wondered what it would be like to take that ride unbuckled. You certainly aren’t risking much for that thrill, are you, with only minutes left to live?

Safety

Safety is best understood as reduction in risk or uncertainty. In colloquial terms, it is time and trouble taken to reduce the likelihood of unfavorable outcomes. Put in those terms, the equivocal nature of safety is clear. It demands the sacrifice of time – and time is just what you have so little left of. Why should you take much trouble reducing the likelihood of an unfavorable outcome when you will experience the most unfavorable outcome of all within twenty-four hours? Every second of time you spend on safety reduces the time you could be spending experiencing pleasure; every bit of trouble you take avoiding risk lowers your potential for happiness during the dwindling time you have left.

Now is the time for you to go hang gliding, even launching off a mountain top if the idea takes your fancy. Bungee jumping is another good candidate. In neither case will you spend an hour or two inspecting your equipment for defects or weakness.

Of course, we know that safety is a significant concern for all of us in our daily lives. That is one of the changes introduced by the reversion to reality in our model. Comparing reality to the polar extreme of our reductio ad absurdum outlines the continuum of risk, benefit and safety.

The Reality of Risk, Benefit and Safety

Reality differs from our artificial example in key respects. Although a relative few of us actually do have only twenty-four hours to live, only a tiny few of that few know (or suspect) the truth. And of those, virtually none have the freedom and vitality accorded our example individual. That clearly affects the central conclusions reached by our model – that the individual would seek out pleasure, eschew work, embrace risk if doing so heightened pleasure significantly and “purchase” little safety at the cost of foregoing pleasure.

We observe, and instinctively realize, that most people must work in order to earn income with which to buy pleasurable consumption goods. They tend to be “risk-averse” within relevant ranges of income and wealth; that is, they will buy a lottery ticket but not play roulette with the rent money. They value safety, but nowhere nearly to the extent implied by the mainstream news media and politicians. In a world of work and production, safety is produced using time and physical resources, which reduces the value of pleasurable goods produced because that time and those resources cannot then be used to produce pleasure. Thus, safety production adds to the money cost and price of consumption goods, which creates a tradeoff between safety and purchasing power. Nobel Laureate George Stigler once colorfully averred that he would rather crash once every 500,000 takeoffs than pay a fortune to fly between major U.S. cities.

In other words, the insights gained from our reductio ad absurdum turn out to be surprisingly useful. We merely have to adjust for the length, variability and unpredictability of actual life spans in order to predict the general character of human behavior in the face of risk. And when we apply these adjustments retroactively, we appreciate how badly astray the mainstream historical view of safety has led us.

Rewriting (Pseudo) History

The mainstream view contains at least a grain of truth in its suggestion that the emphasis on safety is a modern development. But the blame attached to profit-hungry capitalists is wrongheaded. This is not because capitalists aren’t profit-hungry; they most certainly are. But the hunger for profits has always been strong even as the production and consumption of safety have varied. Profit-hunger did not suppress safety for centuries, could not prevent the demand for safety from arising and cannot put it back into the bottle now that it has emerged.

The industrial revolution and the rise of free markets created a tremendous increase in human productivity, thereby increasing real incomes throughout the world. The increases were not uniform; certain countries benefitted much more, and faster, than others. The higher incomes increased the demand for safety and for medical research, which in turn led to tremendous gains in life expectancy.

Longer life spans increased the demand for safety even more. This is our reductio ad absurdum played out in reverse. The longer we expect to live, the more future value we are safeguarding by sacrificing present pleasure with our “purchases” of safety. Prior to the 20th century, with life expectancies at birth not much over 50 years even in the developed industrial nations, it didn’t pay to make great sacrifices in current consumption to safeguard the safety of many people whose longevity was limited anyway. But as life expectancy steadily lengthened – particularly for those in the later stages of life – the terms of the tradeoff changed dramatically.

Risk Compensation

Another factor that greatly affects the balance between risk and safety also emerged in our artificial example. We noted that many of the pleasure-producing human activities carry risk along with their beneficial properties; indeed, therisk itself may even be the source of pleasure. This is true of a wide range of human pursuits, ranging from the rollercoaster rise in our model to auto racing, casino gambling and bungee jumping. Some pastimes such as mountain climbing and hang gliding may produce secondary benefits like physical fitness to supplement their primary purpose of slaking a thirst for risk.

Mainstream society has traditionally viewed risky activities ambivalently. It has tolerated some (mountain-climbing) and frowned on others (gambling, illicit drug-taking) without acknowledging the bedrock similarity common to all. That failure has not only caused much needless death and suffering but has also endangered our freedoms.

Strongly influenced by mid-century muckraker Ralph Nader’s research on the Chevrolet Corvair (later discredited), the U.S. Congress passed legislation beginning in the 1960s requiring American automakers to include safety equipment on all vehicles as standard equipment rather than optional extras. Those safety features included safety belts and, eventually, crash bags. Starting in 1975, University of Chicago economist Sam Peltzman published studies of the results of this legislation. His work showed that any lives that might have been saved among occupants of vehicles tended to be offset by lives lost among pedestrians, cyclists and other non-occupants. That was not to deny the existence of a trend toward fewer highway vehicle deaths. Indeed, that trend had been underway well before the safety legislation was passed owing to factors such as improvements in vehicle design, production and maintenance. Sorting out the effects of this trend from those of the legislation required considerable statistical effort, not to say guesswork.

But the existence of a countervailing force was clear. Peltzman suggested that the safety devices made people feel safer, causing them to drive less carefully. This might be due to increased carelessness or a willingness to embrace a certain level of risk when driving, which caused them to compensate for their increasedlevel of personal protection by taking additional driving risks.

Politicians, regulators and do-gooders of all sorts went ballistic when confronted with Peltzman’s conclusions. How dare he suggest that federal-government safety legislation was anything less than a shining example of nobility and good intentions at work? Rather than ponder the implications of his analysis, they hardened their position. Not only did they force businesses to produce safety, they began forcing consumers to consume safety as well. This campaign began with mandatory seat-belt legislation requiring first drivers, then passengers and eventually children to wear seat belts while vehicles were in operation.

Essentially, the implications of the regulatory position were that markets are dysfunctional. In a competitive market, producers not only produce automobiles that provide transportation services, they also provide various complementary features for those autos. One of those features is safety. (In fact, virtually every safety feature was offered by private auto companies before it was required by the government.) Consumers can patronize auto companies and models that provide the most and best safety features, such as seat belts, air bags, anti-lock brakes and more. They can also reject those that omit safety features. Or consumers can choose to reject safety features by buying autos that lack them. Why would they do that? The obvious reason is that safety features require physical resources and engineering talent to provide, making them costly. Consumers may not wish to pay the cost.

By overriding producer decisions and consumer preferences, regulators in effect assert that markets do not work and government commands should replace the voluntary choices made in the marketplace. One obvious problem with this approach is that it creates momentum in the direction of a centrally planned, totalitarian economy and away from a voluntary, free-market one. But for those who believe that the end justifies the means, the loss of freedom may be justified by the greater safety resulting from the regulatory command-and-control approach.

As time went on, however, it became clear that the regulatory approach was not achieving the results claimed for it. Not only were markets being circumvented, but the regulatory nirvana of a risk-free world was no closer to reality. How could this be? What was going wrong?

As far back as 1908, the British equivalent of America’s Auto club urged landowners to cut back their hedges to improve visibility for drivers of the newly invented automobile. A retired Army colonel responded to this appeal by noting that this hedge-trimming had caused unintended consequences: his lawn had been filled with dust caused by zooming motorists who exceeded speed limits and skidded into his yard. When detained by police, the offenders maintained that “it was perfectly safe” to drive so fast because visibility was clear for a long distance. So the colonel changed his mind and let his shrubs grow in order to deter the speeders.

Following Sam Peltzman’s lead, researchers in succeeding decades discovered a myriad of analogous phenomena. The proliferation of wilderness- and mountain-rescue teams induced hikers and climbers to take more and bigger risks, thus assuring that deaths and injuries from hiking and climbing would not decline despite the increase in resources devoted to rescue. Parachute manufacturers built superior rip cords, but chutists pulled the rip cord later because they were more confident of the cord’s resilience. The result was stability of death rates for sky divers. Stronger levees did not reduce the incidence of death, injury and damage from floods because people were induced to remain in floodplain areas rather than move out. Indeed, the desirability of these locations meant that more people moved in when they became more safe, leading to even more deaths, injuries and damage when a flood did occur. Workers who began wearing back supports still suffered injuries from lifting because the safety supports encouraged them to life heavier loads – which overcame the effect of the supports. Research on children who began wearing more protective sports equipment consistently showed that the kids responded by playing more roughly, overriding the benefits of the equipment and continuing the trend toward injuries. Better contraceptives and more effective medical treatments for HIV infection encouraged people to engage in riskier sexual practices, thereby preventing infection rates from declining as much as expected.

The technical term for all these cases is risk compensation. The general public and those with vested interests in government regulation tend to scoff at the concept, but its presence has been confirmed so repeatedly that it is now conventional wisdom. According to the popular purveyor of mainstream science, Smithsonian Magazine, “This counterintuitive idea was introduced in academic circles several years ago and is broadly accepted today…today the issue is not [about] whether it exists but about the degree to which it does.”  We see it “in the workplace, on the playing field, at home, in the air (“Buckle Up Your Seat Belt and Behave,” April 2009, by William Ecenberger).”

The implications of this research for even so widely venerated a government policy as mandatory seat-belt use are startlingly negative. People inclined to use seat belts are unaffected by the laws, but unwilling wearers who are forced to buckle up are presumably risk-loving types. When their seat belts are firmly in place, they will take more driving risks – after all, they must have had a reason for refusing the belt in the first place and risk-preference is the logical explanation. It follows, then, that they must feel safer when buckled in, which implies that they will try to return to their preferred status of risk tolerance. And studies of seat-belt mandates by economists do tend to show this result.

Risk compensation is so widely accepted among scientists outside of government that a Canadian psychologist has carried it to a logical extreme. Gerald J. S. Wilde propounds the philosophy of risk homeostasis, which posits that human beings automatically adjust their behavior to keep their exposure to risk at a constant level, just as the human body regulates its internal temperature at 98.6 degree Fahrenheit despite variations in external conditions.

The Economic View of Risk

We need not carry belief in adjustment to risk this far in order to recognize the futility of government attempts to fit society into a one-size-fits-all risk-free straitjacket. Not only is it a blatant violation of freedom and free markets, it doesn’t even achieve its intended objectives. It is wrong in theory and wrong in practice.

Risk is not an unambiguous bad thing. It is an unavoidable fact of life toward which different people take widely varying attitudes. For some people, risk is a benefit in and of itself. For practically everybody, risk is a by-product of other beneficial products and activities. Free markets give the most scope for the satisfaction of those different attitudes by allowing the risk-averse to avoid risk and the risk-loving to embrace it – and enabling both groups to do so efficiently via the price system.

Those who claim to see a role for government in allowing the risk-averse to avoid risk are practitioners of what Nobel Laureate Ronald Coase calls “blackboard economics.” This is favored by policymakers standing at a figurative blackboard and divorced from the real-world costs and complications of actually putting their government intervention into operation. In practice, risk and safety policies are delegated to regulators who issue orders and run roughshod over markets. The end result benefits regulators by increasing the size and power of government. The rest of us are stuck with obeying the regulations and picking up the tab.