The Future Cannot Be Calculated

Last autumn, European Central Bank President Christine Lagarde claimed that uncertainty in the economy had decreased significantly. According to her, this would be a result of the EU’s new trade agreement with the USA.

Reduced uncertainty, economists often say, usually means improved prospects for economic growth. Just a few months later, US President Donald Trump suddenly threatened several EU countries, including Sweden, with punitive tariffs. In hindsight, one might wonder if Lagarde’s uncertainty had actually decreased. Or did it perhaps just look that way to her?

Already over a century ago, the economist Frank Knight distinguished between risk and uncertainty. Risk can be measured and calculated. For example, the probability of rolling a one with a regular die is 1 in 6. Gennuine uncertainty, on the other hand, is when we cannot even guess the probabilities. The difference is crucial.

“Probability, it must mean something akin to truth. But it’s not quite as true as truth if it’s probable,” said Tage Danielsson in 1979.

Remember 2010? Back then, Greek government bonds were classified as completely risk-free investments by EU institutions. The official assessments underpinning the banks’ risk calculations considered a Greek payment default an impossibility. A few years later, the sovereign default was a fact. The probability was claimed to be 0%, but was that really true?

Paul Volcker, former chairman of the US Federal Reserve, wrote in his memoirs that such “risk-free” assets fueled both the 2008 global financial crisis and the 2011 European debt crisis.

An evolutionary example: 350 million years ago, trees developed lignin, which meant they could no longer decompose. Undecayed tree trunks piled up across the earth. After a while, fungi developed enzymes that enabled the decomposition of wood. Could anyone have calculated the probability of this?

Even with more knowledge, such “Knightian” uncertainty cannot actually decrease. Uncertainty is instead a fundamental property of complex systems like the economy, nature, and society.

“The future is more difficult to decipher than ever,” writes a Swedish economist. “A lot is happening in the world,” announces Sweden’s Prime Minister Ulf Kristersson. Others lament the “shaky state of the world.”

The difference between risk and uncertainty may seem academic, but it is not. We prefer to talk about known probabilities rather than admit that sometimes we have no clue. The danger in listening to Lagarde or similar “experts” lies in the seduction: she makes us believe the world’s unpredictability can be reduced to calculable problems. This is an illusion that leaves us vulnerable.

If our goal is genuine preparedness, we must embrace Knight’s century-old distinction. A society that acknowledges the world’s fundamental unpredictability would be better prepared for the future. Perhaps then we would also be spared hearing that “defense is a special interest”, as Sweden’s former prime minister Reinfeldt once said, the next time it is claimed that uncertainty has decreased.