Gambling...life vs power...literally

Gambling with the planet

Japan's disaster and the global recession provide stark lessons on societies' failure to manage risks, economist says. Last Modified: 06 Apr 2011 14:14

American economic gurus deluded the rest of society by boasting about "innovating financial instruments" that would "mitigate risk" [GALLO/GETTY] The consequences of the Japanese earthquake - especially the ongoing crisis at the Fukushima nuclear power plant - resonate grimly for observers of the American financial crash that precipitated the Great Recession. Both events provide stark lessons about risks, and about how badly markets and societies can manage them. Of course, in one sense, there is no comparison between the tragedy of the earthquake - which has left more than 25,000 people dead or missing - and the financial crisis, to which no such acute physical suffering can be attributed. But when it comes to the nuclear meltdown at Fukushima, there is a common theme in the two events. Experts in both the nuclear and finance industries assured us that new technology had all but eliminated the risk of catastrophe. Events proved them wrong: not only did the risks exist, but their consequences were so enormous that they easily erased all the supposed benefits of the systems that industry leaders promoted. Before the Great Recession, America’s economic gurus - from the head of the Federal Reserve to the titans of finance - boasted that we had learned to master risk. "Innovative" financial instruments such as derivatives and credit-default swaps enabled the distribution of risk throughout the economy. We now know that they deluded not only the rest of society, but even themselves. These wizards of finance, it turned out, didn’t understand the intricacies of risk, let alone the dangers posed by "fat-tail distributions"- a statistical term for rare events with huge consequences, sometimes called "black swans". Events that were supposed to happen once in a century - or even once in the lifetime of the universe - seemed to happen every ten years. Worse, not only was the frequency of these events vastly underestimated; so was the astronomical damage they would cause - something like the meltdowns that keep dogging the nuclear industry. Research in economics and psychology helps us understand why we do such a bad job in managing these risks. We have little empirical basis for judging rare events, so it is difficult to arrive at good estimates. In such circumstances, more than wishful thinking can come into play: we might have few incentives to think hard at all. On the contrary, when others bear the costs of mistakes, the incentives favour self-delusion. A system that socialises losses and privatises gains is doomed to mismanage risk. Indeed, the entire financial sector was rife with agency problems and externalities. Ratings agencies had incentives to give good ratings to the high-risk securities produced by the investment banks that were paying them. Mortgage originators bore no consequences for their irresponsibility, and even those who engaged in predatory lending or created and marketed securities that were designed to lose did so in ways that insulated them from civil and criminal prosecution. This brings us to the next question: are there other "black swan" events waiting to happen? Unfortunately, some of the really big risks that we face today are most likely not even rare events. The good news is that such risks can be controlled at little or no cost. The bad news is that doing so faces strong political opposition - for there are people who profit from the status quo. We have seen two of the big risks in recent years, but have done little to bring them under control. By some accounts, how the last crisis was managed may have increased the risk of a future financial meltdown. Too-big-to fail banks, and the markets in which they participate, now know that they can expect to be bailed out if they get into trouble. As a result of this "moral hazard", these banks can borrow on favourable terms, giving them a competitive advantage based not on superior performance but on political strength. While some of the excesses in risk-taking have been curbed, predatory lending and unregulated trading in obscure over-the-counter derivatives continue. Incentive structures that encourage excess risk-taking remain virtually unchanged. So, too, while Germany has shut down its older nuclear reactors, in the US and elsewhere, even plants that have the same flawed design as Fukushima continue to operate. The nuclear industry’s very existence is dependent on hidden public subsidies - costs borne by society in the event of nuclear disaster, as well as the costs of the still-unmanaged disposal of nuclear waste. So much for unfettered capitalism! For the planet, there is one more risk, which, like the other two, is almost a certainty: global warming and climate change. If there were other planets to which we could move at low cost in the event of the almost certain outcome predicted by scientists, one could argue that this is a risk worth taking. But there aren’t, so it isn’t. The costs of reducing emissions pale in comparison to the possible risks the world faces. And that is true even if we rule out the nuclear option (the costs of which were always underestimated). To be sure, coal and oil companies would suffer, and big polluting countries - like the US - would obviously pay a higher price than those with a less profligate lifestyle. In the end, those gambling in Las Vegas lose more than they gain. As a society, we are gambling – with our big banks, with our nuclear power facilities, with our planet. As in Las Vegas, the lucky few - the bankers that put our economy at risk and the owners of energy companies that put our planet at risk - may walk off with a mint. But on average and almost certainly, we as a society, like all gamblers, will lose. That, unfortunately, is a lesson of Japan’s disaster that we continue to ignore at our peril. Joseph E. Stiglitz is University Professor at Columbia University and a Nobel laureate in Economics. His latest book, Freefall: Free Markets and the Sinking of the Global Economy, is available in French, German, Japanese, and Spanish. The article was first published by Project Syndicate.  http://www.aljazeera.com/indepth/opinion/2011/04/201146115727852843.html 1.      What is the link to Crisis Management?  Black swan events are defined as events that are a surprise to the observer; after being recorded the event is rationalized by hindsight. The same types of nuclear power plants that were wrecked by the earthquake in Japan exist in the US. Not only do they exist in the US but they have also been built on existing active fault lines. Although the issue of nuclear power plants in US is at the risk stage and not crisis yet, it can easily come over to crisis and a very large one if not addressed. Nuclear power plants similar to those in Japan are appealing to the Nuclear Research Council for renewal of their operating term; this term will add 20 years to an already deteriorating nuclear power plant. This is a crisis just waiting to happen.  2.      What stage of Crisis Management does the system appear to be at?  This crisis seems to be at the stage of risk as of now. It can easily move over to crisis if the active fault lines that the power plants have been built on have an earthquake on it. There are many communities surrounding power plants on the east coast and they will be highly affected by such an incident. 3.      How well does the system appear to be handling the situation? 4.      What level of crisis preparedness does the system appear to have?  It seems that all levels of crisis preparedness are completely ready. I say this because if the preparedness did not exist than this issue wouldn't even be up for debate with the government council of America. Ultimately me believing they have prepared for this type of crisis is a highly hopeful assumption. There are no visible signs of any preparation for a crisis of that sort but there must be, since the government is willing to extend the lifespan of nuclear power another 20 years at the cost of hundreds of thousands of civilians.  5.      What personal reactions/feelings does the description trigger in you? This situation triggers feelings of deep concern. It seems that the government’s interest in production of nuclear power at the cost of human life is actually a feasible thing. How devalued is human life now? In countries like Mexico a human life is worth roughly $200; across the border, in the US it is worth around $2000. But these are prices that killers are willing to accept to murder someone. Has the government come up with a price for human life as well? They are willing to pay that price for human lives lost.... 6.      What advice would you offer to those involved?  My advice to the population living around the nuclear power plants that will be renewed is to move elsewhere. Find a job, home, life somewhere where a nuclear power plant is not in their neighbourhood. For the American government it would be to not renew the license for these power plants to operate for another 20 years; especially those ones that are located on active fault lines that an earthquake can happen on anytime.