Should we discount the future for radical uncertainty?

A few points:

1. Whatever the chance that the future (or rather our role in it) simply won’t exist, that should be discounted directly by the relevant probability of extinction.  That said, while I do worry about asteroids, I take this probability to be relatively small over the next five hundred years.

2. Our uncertainty about the future is good reason for performing an expected value calculation, but it does not provide additional reason for time discounting.  It will shape the p’s that go into the expected value calculation.

3. Austrians and Knightians may believe that our uncertainty about the future is deeply radical and that the entire expected value calculation is meaningless. 

I am closer to a Bayesian myself.  But even if we take the Knightian view at face value, it does not diminish the importance of the future.  Whether or not we call expected value calculations "scientific" or "stupid," we still need to make choices about the future.  A woman might think "I simply can’t imagine what sort of man I might marry."  He might even be some hitherto unimagined extraterrestrial being.  But her parents should still set aside some money for the possible ceremony. 

To make the uncertainty stronger and more general, perhaps the parents think "We have *no* idea what will happen with our daughter, marriage or not.  Perhaps she will sell kitchen equipment, perhaps she will be turned into a sweet potato."  In any case there is no general reason for the parents to think they should save less rather than more.  The potential outcome might require a very large expenditure on their part. 

Some of my technically inclined readers are already thinking about the
third derivative of the utility function and the precautionary motive
for saving
.  The intuition is this: if the effect of your savings is very uncertain, you might either eschew savings altogether ("who knows what it will bring?"), or you might feel a need to save all the more.  The third derivative will determine which is the correct decision, and this is not a matter of the discount rate per se.

4. The party analogy: Let’s say you have no idea who will show up at the party (or what the future will look like).  How can you buy the food until you know whether the guests are Hindu, Muslim, or whatever.  Fair enough, perhaps we should wait.  But given the  uncertainty, we might want to set aside more savings for future contingencies, and not spend all the money today. 

Let’s consider this "third derivative" business in a little more detail.  When does radical uncertainty justifiably mean the future should be ignored?  A Christian might believe that he should not save up for Rapture.  Perhaps Rapture, once it comes, will be so different and so unexpected in its nature that current precautions simply were not worth making.  Odds are your mutual fund won’t make it into heaven (or hell?).  Fair enough.

Alternatively, let’s say you are worried about an avian flu pandemic, but you don’t have a good idea what such a pandemic would look like.  You probably still should buy more bottled water, not less, and pickle more kimchee, not less.

The practically-minded can debate which of these two cases more closely resembles global warming.

Comments

Two thoughts:

1) On some egalitarian level, my first reaction to (3) was "why should only
the woman's parents put aside for marriage?" Other than that, I'm all about
(3).

2) My significant other places equal probabilities on all future outcomes.
Thus, thoughts like "we will marry and live happily ever after" are weighted
equally with "you'll leave me for some peppy 23-year-old as soon as I turn 40!"
Either the good states of the world cancel out the bad in expected value terms,
or she doesn't see the bad states of the world as all that bad, because my
equal probability of being a vile cretin or a prince induces no precautionary
saving whatsoever.

Mr. Cowen, asteroids are not the only threat to the human species over the next few years. You said that Nick Bostrom was your favorite young philosopher, haven't you read his papers on existential risk?

I don't quite get the point here. Calculating an expected value is one thing. Determining the discount rate is another, based not on the expected value but, roughly speaking, on the degree of uncertainty. Higher risk=>higher discount rate.

The wedding example is not clear to me, since, obviously, money not spent on the wedding does not disappear, and the wedding can be financed out of "non-wedding" funds. Is there systematic risk here?

Using Barro's (and Rietz’s) explanation to the equity premium puzzle, we should see extreme events (Knightian uncertainties, perhaps) mess up a nice probability distribution by setting its mean onto a loose path. What could people do with a future that does not somewhat converge to an expectation? More kimchee, more sex, less children, perhaps. At that point, the rate of intertemporal substitution is no longer a dependent variable of a messy function, but an individualistic expression. We are looking into a surrealist painting without much perspective†¦

Speaking of bomb shelters, Russia and the US
still have enough nukes to pretty much wipe
out all human life on the planet if the wrong
guys start pushing the wrong buttons (for all
its antiquity, Dr. Strangelove remains not
entirely irrelevant, despite the efforts of
Tom Schelling, who advised on that film). And
relations do seem to be cooling down quite a
bit these days...

Keynes (and Post Keynesians) also harrumph
about radical uncertainty. Keynes's Treatise
on Probability was published in 1921, the same
year as Knight's famous book that distinguished
between risk and uncertainty. Keynes actually
presented a more complex spectrum of intermediate
possibilities than did Knight. If anyone is
curious, I can provide sources, some of which
are even on my website at http://cob.jmu.edu/rosserjb.

And, Matthew Rabin in a paper a couple of years
ago in Econometrica showed that it is not the
third derivative of the wealth function that
determines things in the simple risk case.

While saving resources for a possible future ocurrence is a good idea how do you choose which ones are the best. For example if there is a 1% chance of something not happening it probably isn't a good thing to prepare for or save resources for. What would be the appropriate likely hood for most people to preapare for something? I may think that a 50% chance of something happening is enough to prepare for it, my friend may only start planning for something if it is 90% likely to happen. I'm wondering at what point most people would prepare for an uncertain future event.

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