THE RISK INSTITUTE

Programme of research on society and human uncertainties
  
  L'INSTITUT DU RISQUE  -  ISTITUTO DEL RISCHIO

• Economics is a social ‘science’ originating as a consequence of the industrial revolution, and developing for about two centuries. It is NOT the ‘science’ of economy per se, but of a specific phenomenon starting in the eighteenth century. It concentrates on the manufacturing of goods, and — culturally or philosophically — is linked to a deterministic thinking (rather valid, because useful, until the beginning of last century). From all this
derives the definitions of a series of fundamental concepts: value, equilibrium, productivity, the role of prices (explicit and implicit ones) etc.

• Within this framework the role and place of an important economic sector such as insurance remains secondary (rightly so at the time of Adam Smith). Uncertainty is linked to incomplete information. The basic paradigm is the reference to equilibrium, which implies complete information, even if in our era this is still admittedly imperfect. In this
perspective, science is implicitly considered as a means to reduce the information gap and finally to eliminate it. And insurance with it. So, why bother to integrate insurance (and risk management) in the basic studying and learning of economics? The very idea of imperfection is wrong as it is based on a kind of ideological determinism.

• The point is that information is by nature ‘imperfect’, because the value (economic value) is not the result of a static equilibrium, but of a dynamic disequilibrium. Even when economists like Samuelson admit dynamic analysis, the phenomena analysed are presented as series of sequentially static states.

• To really understand this, one has to go back to the process of producing wealth: the first step is to recognise that services today are production functions for over 80% of all resources used. Services are NOT a sector, but production tools in all economic activities. The most advanced ‘manufacturing-industrial’ companies are those where service functions are dominant: research, development, quality control in ‘production’, information, storage, distribution, utilisation, etc. and finally waste management (the ecological issues are totally integrated in the modern economic cycle in this way).

• The second step is to realise that the value of a service-based economy is not dependent on the existence of a ‘product’ (even if this is a service), but in its performance in time: this is the source of two basic forms of uncertainties. The first refers to the duration of performance in (future) time. The second to the events which might alter the mode and quality of this performance (and here we rediscover the notion of Risk Management).

All this leads to the idea that the pricing system of insurance is NOT just an odd case with reference to the rest of the economy (the famous question of the reversal of the costs and prices cycle): in the service economy, the pricing system of insurance based on uncertainty is now at the core of the whole economy. Whenever a ‘product’ is sold today, its future performance will add to the present price paid future foreseen and unforeseeable costs. In most cases, higher than the cost of the initial ‘product’. Some ‘products’ then, as in the case of waste management and
environmental costs, become a sort of negative public goods often paid by taxes (determined ex post). The liability explosion is strictly interconnected with this issue.

It seems a paradox, but insurance (and risk management) is simply at the core of the modern, service-based economy. Just the opposite of the normal, current perception and understanding. For the moment, insurance will not make considerable progress as long as the basics of economics are still the ones deriving from the traditional (no longer existing in fact) industrial-manufacturing era. Obviously there is no question of services totally replacing manufacturing. They are both needed: there is no service without a tool and vice-versa. The question is just a reversal in the priorities (from hard products to services). And this alters the notion of value, from the one fixed in an equilibrium system between supply and demand at a given moment in time, to the one in which any price given
at any moment in time is just a contract or commitment such as an insurance policy: most of the costs in the ‘utilisation’ process — or performance — (determining the real value of any economic system) intervene ‘later’ in time, and are inevitably just ‘probable’.

Linked to this process (and to the impact of technology) is an understanding of the notion of vulnerability as a basic reference to risk management. For more details on this issue, see the study on “The Limits to Certainty — Managing Risk in the Service Economy” published under the auspices of The Risk Institute and The Club of Rome. (See the video)