The Philosophy of Risk
Risk is not something that concerns only mathematicians and financiers – it is also of interest to philosophers. Whenever we start to think about things such as threats, hazards, damage, harm or loss, we are making a value judgement that inevitably involves ethical considerations. To what extent is it legitimate, for example, to take a substantial risk when the anticipated benefits are even higher – especially if other people could also be harmed in the process? It is impossible to answer such questions using empirical risk assessment methods alone.
Three phases involved in dealing with risk
The process of dealing with risk can essentially be divided into three phases: risk identification, risk evaluation and risk assessment. The first phase – identifying the risk – is concerned with the question of what constitutes a risk or what situations should be regarded as risky. The second phase – evaluating the risk – poses two questions which (implicitly, at least) attach varying degrees of importance to the probability of risky situations and to the potential harm or loss that they could inflict. The first question is ‘how high is the risk?’ (focus on probabilities) and the second is ‘how large is the risk?’ (focus on potential harm or loss). The third phase – assessing the risk – considers normative aspects such as whether a previously identified and evaluated risk is justifiable and/or acceptable.
Risk assessments can differ significantly when financial policy decisions are being discussed
In practice – when new technologies or financial policy decisions are being discussed, for example – risk assessments, estimates of the frequency of the anticipated harm or loss and, therefore, opinions on the right way to deal with risk can differ significantly. These contrasting views are often a product of imperfect information or irrational use of the information available. The years leading up to the global financial crisis of 2008/2009 were characterised, among other things, by inaccurate evaluations of the risks attaching to a number of financial products, a misguided aversion to regulation, and the laughable credit ratings awarded by the rating agencies, which – taken together – resulted in flawed risk assessments. This ultimately produced decisions and strategies that were guided by short-term considerations and an incomplete view of the overall picture and, consequently, caused fundamental instability in financial markets.
The normative dimension of risk
Although information and reliable facts about the reality of risk may in many cases eliminate any inconsistencies and facilitate a more rational debate about risk, these are not sufficient in themselves. Any attempt to deal with risk must, from an ethical standpoint, include a normative dimension that is closely bound up with individual rights and autonomy. It is not acceptable – regardless of the potential economic benefits – to harm or sacrifice a human being. But, more than that, the individuals affected by risk have the fundamental right to decide themselves what risks they wish to take.
It is not acceptable – regardless of the potential economic benefits – to harm a human being
People are responsible for their own lives, and no one else can relieve them of this responsibility (this applies, at least, to all adults of sound mind). Even if we are quite sure that a certain action will bring more benefits than disadvantages for someone, we are not allowed to take this action if the individual concerned explicitly rejects it. Even if a doctor knows that it would be better if his patient were to stop smoking, he is only allowed to make him aware of this fact but cannot ban him from smoking – and he certainly can’t use force. Even well-meaning paternalism restricts a person’s autonomy. An individual’s decisions are paramount, irrespective of whether the considerations leading up to them are totally rational or not. In this case, subjective attitudes are of direct relevance to the moral justification for risk.
Risk management in a market economy
What, then, does the aforementioned emphasis on individual rights mean for ethically sound risk management? In an advanced society that does not suffer from conditions of extreme scarcity and, in principle, can provide everyone with access to basic public goods such as healthcare, education and accommodation, such basic goods are an individual entitlement. No one must be deprived of these goods merely in order to improve other people’s circumstances. In particular those individuals who are less well endowed with basic public goods – i.e. people with a lower quality of life – must be explicitly taken into consideration in all decisions. Even increasing the income of society as a whole cannot be justified if it is achieved at the expense of an individual, unless the person concerned has taken the risk himself or herself. Any compelling risk assessment criterion should not, by and large, be aggregative in nature but, rather, should insist that the specific risk management practices applied can be justified in respect of each individual affected. The question is whether the market can provide the effective decision-making procedures required for this or whether risk management needs to be further institutionalised.
Sellers in a market offer specific bundles of goods that entail benefits and risks. The purchase and sale of goods only takes place if both the seller and the buyer would be better off as a result of this transaction than they would be without it. All transfers of goods in the marketplace thus produce a Pareto-optimal distribution and, consequently, raise no moral concerns about this distribution. In response to this it should be pointed out that such market-based transfers of risk are legitimate only if it can be proven that they have no external effects, in other words if no third parties are affected and it is genuinely the case that only the counterparties conducting this market-based transfer are consciously taking greater risks and enjoying the resultant benefits. However, this is rarely the case. But ethical considerations impose a second necessity as well: a fair and level playing field. If the distribution in the marketplace is already extremely unequal at the outset, this initial inequality is perpetuated, which means that this injustice continues through market-based transfers unless appropriate institutions or the government itself intervene in some form or another. Risk assessments’ often purely aggregative view of potential losses and benefits does not take distribution considerations into account, which means that justice and fairness criteria are totally ignored.
Conclusions on optimising risk
Although risk management practices require a coherent way of dealing with opportunities and threats, they also need to consider ethical criteria that impose limits on the risk optimisation permitted.
Risk management practices also require ethical criteria to be considered
The empirical and ethical dimensions are therefore inextricably linked and, in the same way that risk assessments rely on valid base data, decision-making processes should factor in transparent ethical norms and values.
About the author
Prof. Dr. Julian Nida-Rümelin, born 1954, is one of Germany’s most highly acclaimed philosophers. He was involved in politics in the field of arts and culture from 1998 to 2002 and teaches philosophy and political theory at the University of Munich. He works closely with the Society of Investment Professionals in Germany (DVFA) to provide ethically sensitive training for financial managers, is co-founder of the executive master’s degree in philosophy, politics and economics (at the University of Munich) and is director of the Parmenides Academy, which advises managers and other decision makers on ethical matters.