Not risk, reward by mattsteinglass
February 27, 2009, 10:04 pm
Filed under: Uncategorized

I’ve been reading Niall Ferguson’s The Ascent of Money and I’ve just gotten to the chapter on Milton Friedman and the Chicago School, which Ferguson entitles “The Return of Risk”. Here’s my question: isn’t calling for a return of “risk” distinctly off point? The chapter concerns Friedman’s insight that excessively generous social welfare systems in Britain and elsewhere had removed the incentive to work and to create value, and this was destroying productivity growth. Hence part of Friedman’s message to Chile when he became an advisor to the Pinochet regime was to dismantle parts of the social safety net that discouraged work.

But what’s pernicious about excessively generous non-means-tested social welfare programs is not that they remove risk; it’s that they remove the incentive to work and create value. Indeed, on P.215 Ferguson cites Friedman’s most important disciple in the Chilean reforms, the young Harvard-trained economist Jose Pinera:

What had begun as a system of large-scale insurance had simply become a system of taxation, with today’s contributions being used to pay today’s benefits…This ‘pay-as-you-go’ approach had replaced the principle of thrift with the practice of entitlement…[But this approach] is rooted in a false conception of how human beings behave. It destroys, at the individual level, the link between contributions and benefits. In other words, between effort and reward.

Pinera doesn’t speak of “risk” here. He speaks of effort and reward. It is crucial for economic growth to reward work and value creation. But it is not crucial to maintain risk. Indeed, it’s actually crucial to reduce risk in order to encourage economic growth, because risk discourages people from working and investing. That is the reason for the existence of the insurance industry: in a 17th-century economy where a merchant bore the entire cost if his ship went down in a storm, fewer merchants would invest in shipping, and the economy would be less prosperous. Similarly, if quitting a low-productivity job for a higher-productivity one risks losing your health insurance, fewer people will quit their low-productivity jobs, producing labor market rigidity and inefficiency.

In recent decades wealthy people involved in finance and business have tended to argue that they deserve to keep the overwhelming portion of their incomes rather than see them taxed, because they earned their incomes by braving high levels of risk. This argument may or may not be valid. But Ferguson seems to be implicitly allowing the conservative belief that those who risk more are entitled to greater winnings to morph into a belief that risk, as such, creates wealth, and that therefore a riskier economy will be a more prosperous one. This seems to me to be confused. Many of the greatest characteristics of the American economy — lax bankruptcy laws, for example, which allow people to start up businesses without risking losing everything they’ve got — are precisely devices for reducing risk, to give people greater freedom to experiment, invest, and achieve.


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