Thursday, March 31, 2016

The Economics of Risk

For this activity, I told the children that they had to jump down the stairs from the very highest step they were willing to jump from. Whoever jumped from the highest step would win. I must admit this made me cringe as they went up higher and higher, but luckily they had SOME self-awareness and eventually they all refused to go any higher. 
Then, I covered the floor at the bottom of the stairs with pillows and asked the children which step they were willing to jump from NOW. In every case, of course, they were willing to jump from a higher stair. And this led nicely into our discussion of how sometimes reducing the COST of risk, leads people to take GREATER risks.

Here's Thomas Sowell on that subject, from page 135 of Applied Economics:
To some extent…reducing risk through insurance may cause people to take more risks. Just as lower prices for other things usually cause more to be demanded, so lowering the costs of given risks enables people to take on additional risks… 
If you were driving a car without brakes, or with brakes that you knew to be less effective, it might be foolhardy to drive faster than 10 or 15 miles per hour. …But, when you have well-functioning brakes as a risk-reducing device, you may well drive 60 miles an hour on a crowded highway. Thus brakes reduce the dangers in a given situation but also encourage people to drive in more dangerous situations than they would otherwise. This does not mean that safety devices are futile. It means that the benefits of such devices include benefits over and beyond any benefits from net reductions of risks. For example, because cars are able to travel at higher speeds, more extensive travel for business or pleasure becomes feasible.
(He discusses elsewhere how the same is often true with healthcare. When people don't pay the costs of their own healthcare, they tend to use more healthcare, and to use it less efficiently. This in turn leads to other costs, such as shortages, wait times, decline in quality of care, and so forth.)

We also talked about how safety and risk-reduction, like most things in life, requires analysis of costs and benefits:
(pg 161) Safety might seem to be something that you cannot get too much of. Yet everything we do in our everyday lives belies that conclusion. Often what we do makes more sense than what we say. 
Reducing risks has costs, some of which we are willing to pay and some of which we are not willing to pay. Moreover, not all costs are money costs. For many people, the costs of reducing risks would be giving up the enjoyment they get from skiing, boating, rock climbing, skateboarding, and other risky activities. In fact, ultimately there are only risky activities, since nothing is 100 percent safe. Yet no one suggests that we retire into passive inactivity—which has its own risks.…On the other hand, most of us are not prepared to take a short cut by walking across a freeway during the rush hour. In other words, there are risks we are willing to take and risks we are not willing to take, varying somewhat from person to person, but involving a weighing of benefits and costs in any event. 
In short, even those who talk about safety in categorical terms—"if it saves just one life, it is worth whatever it costs"—actually behave in their own lives as if safety is an incremental decision, based on weighing costs against benefits, not a categorical decision.
(pg 143) Our natural inclination may be to want to make every place as safe as possible, but in reality, no one does that when they must pay the costs themselves. We are willing to pay for brakes in our cars, but having a second set of brakes in case the first set fails would make us safer still, and a third set would result in still more reduction of risk… However, faced with rising costs and declining reductions of risk as more backup brakes are added to automobiles, most people will at some point refuse to pay any more for additional but insignificant reductions in risk. However, if someone else is paying for reductions in risk, the point at which risk reduction stops may be very different. Lawsuits can impose costs that shut down a playground that is safer than any alternative place the children are likely to be, including their homes.
The implicit assumption that zero risk can be taken as a benchmark for assessing blame for particular risks can easily lead to higher risks than if it was understood from the outset that one risk must be weighed against another, not compared to zero risk or even to some arbitrary standard of "acceptable" versus "unacceptable" risk.
Thomas Sowell talks about how this calculus is changed when government, "non-profit" or private organizations get involved in imposing safety requirements.
(pg 144) Since these organizations do not charge directly for their services like…insurance companies, they must collect the money needed to support themselves from lawsuits, donations, or taxes. Put differently, their only money-making product or service is fear—and their incentives are to induce as much fear as possible in jurors, legislators, and the general public. 
Whereas individuals weighing risks for themselves are restrained in how much risk reduction they will seek by the costs of reducing those risks, there are no such restraints on the amount of risk reduction sought by those whose risk reduction is paid for with other people's money… 
The central question of how much risk is to be reduced at what costs is usually not raised at all by third-party safety organizations or movements. Not are alternative risks weighed against one another. Instead, the theme is that something is "unsafe" and therefore needs to be made safe. 
This kind of argument can be applied to almost anything, since nothing is literally 100 percent safe. It has been used against medications, pesticides, nuclear power, automobiles, and many other targets… 
In the case of nuclear power, the question of safety, in addition to cost, is: Compared to what?…Once the discussion changes to a discussion of incremental trade-offs, then nuclear power becomes one of the safest options. But neither it nor anything else is categorically safe.
This is why it drives me so crazy when third parties get involved in things like whether or not parents "should" let their children walk to school, play at the park alone, eliminate all allergens from their environment, allow them to consume certain foods, and so forth. Someone with absolutely no investment in paying the costs of these choices should not and CANNOT make as good of a decision as the parent who must actually pay them. I was just talking to a friend about how so many people are willing to give well-meaning advice about how much effort should be put into treating allergies or "child-proofing" a house—but in reality, each family must weigh the costs and benefits and make those choices for themselves. And this should be able to take place without third parties jumping in with accusations of "bad parenting"! See also the free-range kids movement, which makes many of these same points.

All this made for very lively discussions with the children. I talked about some of the risks they can choose for themselves, and others that we as their parents will make for them until they are older—but they loved talking about what THEY think they will do with their OWN children, when the time comes. We also had some interesting conversations about things like the regulation of organ donation, prescription drugs, hospitals, etc. What kinds of costs and benefits might these regulations have? Which things did the children think ought to be under government oversight? And why? I love discussing this type of thing and it was fun to see them begin to think about it as well.

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