Risk is one of the core concepts of political economy. In this paper I will examine the evolution of different notions of risk from pre-feudal to modern, placing them in the economic paradigms of their time. In particular showing how the development of property rights, contract and the state led to the concepts of capital, markets and institutions. Capital, in its incessant quest to accumulate, engages in a rhetoric of self justification that masks the risk shifting necessary for this accumulation. It also manipulates institutions to these ends. But it is these institutions that are also the agents necessary to protect the rights of non-capitalists. So the strong protect the weak whilst exploiting them in a process of cumulative causation beginning in pre history.
From pre history small groups of family based clans merged into tribes and took up land in common to create small towns with attached areas for farming and grazing of animals. (Lafargue,1905) These democracies were at risk from bands of roving outcasts who robbed, murdered and raped. As more powerful individuals and families could afford sturdier places of defence a system of patronage developed that bound the weaker to the stronger. (Painter,1951) In return for protection, serfs agreed to provide the human power to work the fields, tend the animals and provide the fighters necessary to sustain survival. (Lafargue, 1905) Gradually the most powerful disbanded the democracies and installed a hierarchy from serf to king with a constant battle for supremacy within and between groups. (Lafargue, 1905) The risks were now not from roving bandits but the organised armies of rival kings. (Painter, 1951). The break-up of ownership of land in common lead to the development of tenancy. (Alston, 2002)
The concept pre-dated feudalism. Athenians and Romans leased conquered lands back to the original owners. (Alston, 2002). Prior to the Black Death (1347-1352) serfs were customary tenants. (Alston, 2002) Serfs gained a copy of their leases as an improvement in their rights as a result of the labour shortage following the devastation of the available labour force. (Alston, 2002). These could be passed onto heirs and fixed the amount of output due the landowner. The tenant’s right of access to and output from the land was in contrast to the wageworker or sharecropper whose access was at the discretion of the landowner and was only owed a wage or share of the output. (Alston, 2002). These legal and customary distinctions have important economic implications for the distribution of risk between landlords and those who work the land. (Alston, 2002). These risks included yield risk, the deviation from expected output and price risk, deviation from expected price. Further risk arose from the degree of monopoly power enjoyed by landowner or tenant at any given point in the economic cycle. Share croppers and share tenants bear risk with the landlord proportional to their share of the crop. Wage workers bore no risk provided the landlord could afford to pay cash irrespective of the yield or price. (Alston, 2002) The migration of wageworkers to the factories began with the advent of industrialization. They carried these contractual conventions and their understanding of risk with them. Similarly landlords and the new capitalists used the same set of legal and cultural conventions with the mindset that came with them. The capital needed to build the new factories was larger than previously required to fund trading ventures or land acquisitions and led to the development of new mechanisms for apportioning risk.
The unlimited liability of partnerships was superseded by the limited liability of shares in a joint stock company as a mechanism for sharing risk. Shares and options were traded on exchanges in Amsterdam from the beginning of the 17th Century and gradually spread to every part of the world. During the late 18th century the joint stock company evolved into a dynamic driver of an expanding global economy. (Monks, 1998). Moral philosophers such as Adam Smith observed this unfolding phenomenon and noted how corporations restrained competition by forming monopolies. (Eatwell in Argyrous & Stilwell, 2003). The state, in the form of the king or queen granted these monopolies to minimise the risk and extract the maximum profit from their investment. Domestically, corporations such as The Cutlers Company were granted royal patents to control entry into the production of essential items. (Eatwell in Argyrous & Stilwell, 2003). This illustrates a point Polanyi made; states create the conditions necessary for markets and enforce the property rights that shape the incentive structure of the economy. (Polanyi, 1944) In his view, until the end of the18th century the market was no more than incidental to economic life. (Polanyi, 1944). Subsistence livelihood was guaranteed as a moral right; the economy was embedded in society. (Dalton, 1968). I suggest the history of financial markets support this.
Thorstein Veblen (1919) defined institutions as settled habits of thought common to the generality of men. Financial markets are such institutions and are deemed necessary to shift risk. The justification was markets would not be anarchic but would provide a co-ordination, directing individual self interest towards social benefit. (Eatwell in Argyrous & Stilwell 2003) As the role of the entrepreneur in the production process increased, she needed access to finance. Financial entrepreneurs become prominent. Schumpeter (1942) postulated a theory of creative destruction to account for the role of the entrepreneur in a market economy. Creative efforts are risky because some efforts will fail or yield little. Profits from creativity make capitalism powerful because entrepreneurs benefit from short run monopolies. Creative destruction implies risk so the forces that oppose creativity are not irrational; they are the natural concerns of economic agents who will be affected. (Nakamura, 2000 p21). Entrepreneurs are confronted with the principal of increasing risk according to Kalecki. (1990, p.288) The more she wishes to borrow relative to profits and to her own wealth the greater is the perceived risk on both the potential lender and the borrower. The lender will charge a risk premium to cover this greater risk exposure but this raises the cost of borrowing further, perhaps to the point of being prohibitive. (Kalecki, 1990) The individual self interest of the entrepreneur and the mechanism of its application to risky ventures became a topic of interest.
In 1738 Daniel Bernoulli proposed a theory to explain why individuals accept risk. (New School, 2004) He decomposed the valuation of a risky venture as the sum of utilities from outcomes weighted by the probability of the outcomes. This assumes diminishing marginal utility and implies a gain would increase utility less than a decline would reduce it which intuitively suggests the willingness to take on risk must be irrational. (New School, 2004) The solution to the St. Petersburg Paradox challenges the idea people value random ventures according to expected return and eventually led to the expected utility hypothesis. The paradox lay in the fact people would not pay an infinite amount to gain an infinite return. Bernoulli’s solution involved two ideas. People’s utility from wealth is not linearly related to wealth but rather increases at a decreasing rate and the valuation of any risky venture takes the form of a utility function over the outcomes of the form:
E(u p, X) = å xÎ X p(x)u(x)
where X is the set of possible outcomes, p(x) is the probability of a particular outcome x Î X and u: X ® R is the utility function. (New School, 2004)
Bernoulli’s solution implies people get utility from the outcome and the assignment of probabilities is subjective. More than two hundred years later, von Neumann and Morgenstern used an axiomatic proof to show it is possible people gain utility from the process of risky choices combined with objective probabilities from which we can deduce preferences. (New School, 2004). The difference lies in the von Neumann and Morgenstern insight; avoid defining preferences over outcomes and capture everything in terms of preferences over the risky choices and from that deduce the implied preferences over the underlying outcomes. (New School, 2004). Thus was encapsulated the idea of free agents making choices in free markets. But I have tentatively established financial markets are constructs for the re-allocation of profits, maintained by the state to serve the interests of capital. It could be said the debate about free markets is largely rhetorical (Bryan, 2000) There has always been a regulated policy agenda that asserts the social, cultural and economic rule of capital. Arguments about ‘free markets’ fail to recognise this and are not adequate for a complete policy analysis. (Bryan, 2000) Marx and other socialists had a more expansive view.
Marx implied there was no place for risk in the distribution of profits from the production of surplus value. (Marx, 1848) Capitalists divided profit on the basis of their relative power in a dialectical struggle. He suggested the rate of profit would fall to a long run average and so there is little need for the risk taking entrepreneur. (Marx, 1848). This accumulation of profit cannot take place in a state of chaos. (Gordon, Weisskopf, and Bowles, p256) A social structure of accumulation including stability of the financial system is needed. Minsky suggested risks from the volatility of financial markets are endemic. He argued there are three income-debt relations for economic units; hedge, speculative and ponzi finance. (Minsky, in Argyrous & Stilwell 2003) The financial instability thesis contends business cycles are compounded out of the system of interventions and regulations designed to keep the economy in the equilibrium seeking and deviation containing state associated with hedge financing. (Minsky, in Argyrous & Stilwell 2003) Hayek’s Road to Sefdom argues that departures from the self regulating market system must erode political democracy and personal freedom. (Dalton, 1968) Others have argued collusive acts that use coercive means to prevent voluntary exchanges can lead to market inefficiencies (Friedman.1962). In this analysis correct state policy can create long-term stability only if carefully balanced between the individual self maximizer and the need for systemic stability as a mitigator of risk. Thus stabilizing society between the risks of totalitarian extremes of left and right becomes the aim because it is ideas not vested interests which are dangerous (Keynes, 1936 Ch12) It is ideas and policies that are said to conform to natural justice or are in the national interest that help form our perceptions of risk.(Eatwell in Argyrous & Stilwell 2003)
According to the theory of reflexivity, misconceptions or flawed ideas are generally responsible for most boom/bust sequences (Soros, 1994) This reflexivity is a two-way feed back mechanism which helps shape reality in an unending process.(Soros,1994) Left to their own devices markets are liable to go to socially disruptive extremes because markets are composed of the thinking of participants which affects the situation to which they refer. (Soros, 1994) In this vein the risks of conventional investment are likened to anticipating what the average opinion thinks- the beauty pageant analogy. (Keynes, 1936 Ch12) He suggests a large potion of our positive activities depends on spontaneous optimism rather than mathematical expectation because investment is boring to those not inclined to taking risks of the gambling kind and it is an innate urge to activity that makes the wheels go round. (Keynes, 1936 Ch12). Speculation is the process of anticipating the short term movement of the market, not investment based on fundamental valuation and so the thought of ultimate loss is put aside or enterprise is stifled. (Keynes, 1936 Ch12) This essentially liberal view of the idea of the need for animal spirits, the entrepreneurial ideal, contrasts with what Soros sees as the modern result- a financial system headed for a major crisis. And what others see as the emergence of the risk society.
The emergence of the risk society takes form in fears about dangerous foods, medical problems and environmental degradation. (Ben-Ami, 2001 p155).
Theoretical elements of risk society connect the end of nature and the end of tradition in the epistemological and cultural status of science and the constitution of politics. (Beck in Franklin, 1998 p9) These internal risks are generated by the process of modernization and follow from the individualization of work, family and self identity. (Franklin, 1998 p10) Uncertainties about the market are inherently larger than uncertainties about technology yet firms continue to invest in pure scientific research. (Callon,1994). They hope to make a distinction between private and public science and restrict the availability of technology to increase profitability. Callon sees this as a failure of the market and calls for a political economy of networks for the production and mobilization of science as a public good. (Callon,1994) On the other hand markets can be seen as consisting of private networks, extending selectively across the world and thus representing a fragmented process of globalisation. (Hasselström, 2003). Thus risks are constructed, negotiated and contested rather than forming a notion of risk society. (Hasselström, 2003) In this way they are distinct from a Callonian view of markets as alienating and are more about entangling and disentangling. (Hasselström, 2003). This could be expanded to include the notion of markets and their interaction with state institutions. The arguments for and against privatisations has raged in the last two decades with profits being generated for those managing the process and the risks being privatised.
Market failures such as natural monopoly or externalities led to the nationalisation and regulation of certain industries. (Quiggin, 2002) Subsequent privatisation created regulatory risk, a fact not taken into account by private buyers and which led to higher prices being paid for these assets. (Quiggin, 2002. Lobbying to reduce regulatory controls has resulted in an increase in a range of risks associated with these enterprises including negative externalities and the return of monopoly inefficiencies. (Quiggin, 2002). The risk premium demanded by equity investors, typically around 6%, is not included in the return from sovereign or high quality corporate risk such as bonds. (Quiggin, 2002). The returns demanded from these privatised enterprises must now factor this in and raise prices and reduce employment to meet the market demands without any increase in economic efficiency. Some argue a pervasive fear of risk taking has led to a shift in the financial sector from raising capital to risk management. (Ben-Ami, 2001 p154). Furthermore companies welcome increasing regulation as a protection against instability. Intervention serves to protect the interests of capital against the risk they willingly assume. (Bryan, 2000). The growth in the demand for derivatives from fund managers as hedge mechanisms is also attributed to this shift from the focus on returns. (Ben-Ami, 2001 p155). In this see-sawing some of the policies that are criticised for restricting free markets are actually serving to save capital from itself. (Bryan, 2000). This confusion is not new and has been systematically employed by the state, proponents of regulation and their detractors. At various times the state has promoted the free market with a fear of the workhouse or transportation and with privatisation of common lands.(McQueen, 2000) At other times exploitation has been seen as wasteful and costly and its reduction necessary for a return to economic security. (Gordon, Weisskopf and Bowles, p259). I argue this is the dialectic of risk shifting employed by the bourgeoisie justifying the returns to capital.
The bourgeoisie are concerned with the maintenance of social stability and moral precepts under the guise of civilization; the more readily to promote naked self interest and cash payment. (Marx in Argyrous & Stilwell 2003). Class conflict or low previous capital accumulation may dispose capitalists to dispose of their profits in other ways. (Gordon, Weisskopf, and Bowles, p257) Ricardo was a successful participant in incipient stock and bond markets. He took his profits and bought land. As a result of close observation of his land owning peers he expounded a theory of crisis following from the returns to rent from productive land rising as less productive land was cultivated. (Ricardo in Argyrous & Stilwell 2003) Rents to landowners were likely to be wasted in his view. He also became concerned with the risk taxation posed to potential investors, a recurrent theme with supply side theorists ever since. (Ricardo in Argyrous & Stilwell 2003) Capitalists and supply side theorists say economic crisis is precipitated by demands for real wage increases. (McNally, 1999) Keynes suggested under-consumption and unemployment led to crisis. The Bank for International Settlements (2001) argues waves of optimism are generated from favourable developments in the real economy which leads to underestimation of risk. Workers are more concerned with the risk of unemployment and the growth of inequality in pay. (Nakamura, 2000 p25) These conflicting or supportive perceptions are blamed for crisis.
In situations of crisis, basic changes in economic and political institutions may be necessary to return to prosperity. (Gordon, Weisskopf, and Bowles, p257) National central banks and the Bank for International Settlements have become prominent in managing risk. (RBA 2004, BIS 2004) The risk of inflation and the destabilizing effect it has on economies has become the dominant preoccupation. For them inflation is the main risk (Bell, 2004) even as the expansion of debt is used to make payments on earlier debt and to bolster domestic demand in an attempt to maintain profits. (McNally, 1999) The risk of financial institution failure and the resultant contagion is being addressed with a range of capital adequacy measures. (Basel Committee Bank Supervision 1999) Increased transparency is demanded from any institution that wants to stay in the global financial market are now mandated. (BCBS 1999) The Australian Prudential Regulation Authority’s mission it to establish and enforce prudential standards so that financial promises made by institutions are kept. (APRA, 2004) The rise of consumer protection has replaced caveat emptor as a principle of business. This has led to the development of institutions like the Australian Competition and Consumer Commission and the Australian Securities Investment Commission. Access to numerous tribunals dispensing quick and cheap arbitration has replaced a monolithic court structure. The whole area of mediation in law has arrived. I suggest this has altered the landscape in the perception of risks by agents. In my opinion the range of risks has not changed, we are developing new institutions to manage them. ACCC makes sure the provisions of the Trade Practices Act for consumer protection are followed. (ACCC Journal No.43 p86) The aim is to strengthen the position of consumers relative to sellers, distributors and manufacturers by ensuring that businesses compete fairly on price and quality, and by implying into consumer contracts non-excludable conditions and warranties as to quality, fitness and title. (ACCC Journal No.43 p86) The development of behavioural economics and finance has led to insights that will influence the development of different political institutions and systems to manage risk. (Gersen, 2002) Individuals respond to social, market and government incentives in ways not necessarily in accordance with theories of rational actors. (Gersen, 2002) Regulation of the insurance industry and its interaction with individual perceptions of risk provides a good example. A previous generation of actors undertook a level of self insurance, perhaps out of ignorance, that was replaced following a wave of public liability litigation. The insurance companies left the market and it required new legislation to limit the level of damages claimable to entice them back. Legislative intervention provided subsidies to health insurance companies following the declining provision of welfare services. (Bryan, 2000). Regulatory interventions are essential to capital in periods of economic instability and increased risk (Bryan, 2000). And they go some way to protect the interests of those most at risk of pillage since the dawn of history.
In conclusion I suggest political economy sees a wider definition of risk than orthodox economics allows. Placing theories of risk in the individual, institutional and political contexts in which they evolve brings the economic rhetoric they generate into relief. From the pre-feudal need for clan survival through the development of property rights and contractual obligations into the risk shifting of modern society this paper has traced the emergence of the risk society. Particular attention has been paid to the role of the state and organised capital in forming, regulating and maintaining markets as mechanisms for privatising risk to increase the returns to the interests of capital
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From pre history small groups of family based clans merged into tribes and took up land in common to create small towns with attached areas for farming and grazing of animals. (Lafargue,1905) These democracies were at risk from bands of roving outcasts who robbed, murdered and raped. As more powerful individuals and families could afford sturdier places of defence a system of patronage developed that bound the weaker to the stronger. (Painter,1951) In return for protection, serfs agreed to provide the human power to work the fields, tend the animals and provide the fighters necessary to sustain survival. (Lafargue, 1905) Gradually the most powerful disbanded the democracies and installed a hierarchy from serf to king with a constant battle for supremacy within and between groups. (Lafargue, 1905) The risks were now not from roving bandits but the organised armies of rival kings. (Painter, 1951). The break-up of ownership of land in common lead to the development of tenancy. (Alston, 2002)
The concept pre-dated feudalism. Athenians and Romans leased conquered lands back to the original owners. (Alston, 2002). Prior to the Black Death (1347-1352) serfs were customary tenants. (Alston, 2002) Serfs gained a copy of their leases as an improvement in their rights as a result of the labour shortage following the devastation of the available labour force. (Alston, 2002). These could be passed onto heirs and fixed the amount of output due the landowner. The tenant’s right of access to and output from the land was in contrast to the wageworker or sharecropper whose access was at the discretion of the landowner and was only owed a wage or share of the output. (Alston, 2002). These legal and customary distinctions have important economic implications for the distribution of risk between landlords and those who work the land. (Alston, 2002). These risks included yield risk, the deviation from expected output and price risk, deviation from expected price. Further risk arose from the degree of monopoly power enjoyed by landowner or tenant at any given point in the economic cycle. Share croppers and share tenants bear risk with the landlord proportional to their share of the crop. Wage workers bore no risk provided the landlord could afford to pay cash irrespective of the yield or price. (Alston, 2002) The migration of wageworkers to the factories began with the advent of industrialization. They carried these contractual conventions and their understanding of risk with them. Similarly landlords and the new capitalists used the same set of legal and cultural conventions with the mindset that came with them. The capital needed to build the new factories was larger than previously required to fund trading ventures or land acquisitions and led to the development of new mechanisms for apportioning risk.
The unlimited liability of partnerships was superseded by the limited liability of shares in a joint stock company as a mechanism for sharing risk. Shares and options were traded on exchanges in Amsterdam from the beginning of the 17th Century and gradually spread to every part of the world. During the late 18th century the joint stock company evolved into a dynamic driver of an expanding global economy. (Monks, 1998). Moral philosophers such as Adam Smith observed this unfolding phenomenon and noted how corporations restrained competition by forming monopolies. (Eatwell in Argyrous & Stilwell, 2003). The state, in the form of the king or queen granted these monopolies to minimise the risk and extract the maximum profit from their investment. Domestically, corporations such as The Cutlers Company were granted royal patents to control entry into the production of essential items. (Eatwell in Argyrous & Stilwell, 2003). This illustrates a point Polanyi made; states create the conditions necessary for markets and enforce the property rights that shape the incentive structure of the economy. (Polanyi, 1944) In his view, until the end of the18th century the market was no more than incidental to economic life. (Polanyi, 1944). Subsistence livelihood was guaranteed as a moral right; the economy was embedded in society. (Dalton, 1968). I suggest the history of financial markets support this.
Thorstein Veblen (1919) defined institutions as settled habits of thought common to the generality of men. Financial markets are such institutions and are deemed necessary to shift risk. The justification was markets would not be anarchic but would provide a co-ordination, directing individual self interest towards social benefit. (Eatwell in Argyrous & Stilwell 2003) As the role of the entrepreneur in the production process increased, she needed access to finance. Financial entrepreneurs become prominent. Schumpeter (1942) postulated a theory of creative destruction to account for the role of the entrepreneur in a market economy. Creative efforts are risky because some efforts will fail or yield little. Profits from creativity make capitalism powerful because entrepreneurs benefit from short run monopolies. Creative destruction implies risk so the forces that oppose creativity are not irrational; they are the natural concerns of economic agents who will be affected. (Nakamura, 2000 p21). Entrepreneurs are confronted with the principal of increasing risk according to Kalecki. (1990, p.288) The more she wishes to borrow relative to profits and to her own wealth the greater is the perceived risk on both the potential lender and the borrower. The lender will charge a risk premium to cover this greater risk exposure but this raises the cost of borrowing further, perhaps to the point of being prohibitive. (Kalecki, 1990) The individual self interest of the entrepreneur and the mechanism of its application to risky ventures became a topic of interest.
In 1738 Daniel Bernoulli proposed a theory to explain why individuals accept risk. (New School, 2004) He decomposed the valuation of a risky venture as the sum of utilities from outcomes weighted by the probability of the outcomes. This assumes diminishing marginal utility and implies a gain would increase utility less than a decline would reduce it which intuitively suggests the willingness to take on risk must be irrational. (New School, 2004) The solution to the St. Petersburg Paradox challenges the idea people value random ventures according to expected return and eventually led to the expected utility hypothesis. The paradox lay in the fact people would not pay an infinite amount to gain an infinite return. Bernoulli’s solution involved two ideas. People’s utility from wealth is not linearly related to wealth but rather increases at a decreasing rate and the valuation of any risky venture takes the form of a utility function over the outcomes of the form:
E(u p, X) = å xÎ X p(x)u(x)
where X is the set of possible outcomes, p(x) is the probability of a particular outcome x Î X and u: X ® R is the utility function. (New School, 2004)
Bernoulli’s solution implies people get utility from the outcome and the assignment of probabilities is subjective. More than two hundred years later, von Neumann and Morgenstern used an axiomatic proof to show it is possible people gain utility from the process of risky choices combined with objective probabilities from which we can deduce preferences. (New School, 2004). The difference lies in the von Neumann and Morgenstern insight; avoid defining preferences over outcomes and capture everything in terms of preferences over the risky choices and from that deduce the implied preferences over the underlying outcomes. (New School, 2004). Thus was encapsulated the idea of free agents making choices in free markets. But I have tentatively established financial markets are constructs for the re-allocation of profits, maintained by the state to serve the interests of capital. It could be said the debate about free markets is largely rhetorical (Bryan, 2000) There has always been a regulated policy agenda that asserts the social, cultural and economic rule of capital. Arguments about ‘free markets’ fail to recognise this and are not adequate for a complete policy analysis. (Bryan, 2000) Marx and other socialists had a more expansive view.
Marx implied there was no place for risk in the distribution of profits from the production of surplus value. (Marx, 1848) Capitalists divided profit on the basis of their relative power in a dialectical struggle. He suggested the rate of profit would fall to a long run average and so there is little need for the risk taking entrepreneur. (Marx, 1848). This accumulation of profit cannot take place in a state of chaos. (Gordon, Weisskopf, and Bowles, p256) A social structure of accumulation including stability of the financial system is needed. Minsky suggested risks from the volatility of financial markets are endemic. He argued there are three income-debt relations for economic units; hedge, speculative and ponzi finance. (Minsky, in Argyrous & Stilwell 2003) The financial instability thesis contends business cycles are compounded out of the system of interventions and regulations designed to keep the economy in the equilibrium seeking and deviation containing state associated with hedge financing. (Minsky, in Argyrous & Stilwell 2003) Hayek’s Road to Sefdom argues that departures from the self regulating market system must erode political democracy and personal freedom. (Dalton, 1968) Others have argued collusive acts that use coercive means to prevent voluntary exchanges can lead to market inefficiencies (Friedman.1962). In this analysis correct state policy can create long-term stability only if carefully balanced between the individual self maximizer and the need for systemic stability as a mitigator of risk. Thus stabilizing society between the risks of totalitarian extremes of left and right becomes the aim because it is ideas not vested interests which are dangerous (Keynes, 1936 Ch12) It is ideas and policies that are said to conform to natural justice or are in the national interest that help form our perceptions of risk.(Eatwell in Argyrous & Stilwell 2003)
According to the theory of reflexivity, misconceptions or flawed ideas are generally responsible for most boom/bust sequences (Soros, 1994) This reflexivity is a two-way feed back mechanism which helps shape reality in an unending process.(Soros,1994) Left to their own devices markets are liable to go to socially disruptive extremes because markets are composed of the thinking of participants which affects the situation to which they refer. (Soros, 1994) In this vein the risks of conventional investment are likened to anticipating what the average opinion thinks- the beauty pageant analogy. (Keynes, 1936 Ch12) He suggests a large potion of our positive activities depends on spontaneous optimism rather than mathematical expectation because investment is boring to those not inclined to taking risks of the gambling kind and it is an innate urge to activity that makes the wheels go round. (Keynes, 1936 Ch12). Speculation is the process of anticipating the short term movement of the market, not investment based on fundamental valuation and so the thought of ultimate loss is put aside or enterprise is stifled. (Keynes, 1936 Ch12) This essentially liberal view of the idea of the need for animal spirits, the entrepreneurial ideal, contrasts with what Soros sees as the modern result- a financial system headed for a major crisis. And what others see as the emergence of the risk society.
The emergence of the risk society takes form in fears about dangerous foods, medical problems and environmental degradation. (Ben-Ami, 2001 p155).
Theoretical elements of risk society connect the end of nature and the end of tradition in the epistemological and cultural status of science and the constitution of politics. (Beck in Franklin, 1998 p9) These internal risks are generated by the process of modernization and follow from the individualization of work, family and self identity. (Franklin, 1998 p10) Uncertainties about the market are inherently larger than uncertainties about technology yet firms continue to invest in pure scientific research. (Callon,1994). They hope to make a distinction between private and public science and restrict the availability of technology to increase profitability. Callon sees this as a failure of the market and calls for a political economy of networks for the production and mobilization of science as a public good. (Callon,1994) On the other hand markets can be seen as consisting of private networks, extending selectively across the world and thus representing a fragmented process of globalisation. (Hasselström, 2003). Thus risks are constructed, negotiated and contested rather than forming a notion of risk society. (Hasselström, 2003) In this way they are distinct from a Callonian view of markets as alienating and are more about entangling and disentangling. (Hasselström, 2003). This could be expanded to include the notion of markets and their interaction with state institutions. The arguments for and against privatisations has raged in the last two decades with profits being generated for those managing the process and the risks being privatised.
Market failures such as natural monopoly or externalities led to the nationalisation and regulation of certain industries. (Quiggin, 2002) Subsequent privatisation created regulatory risk, a fact not taken into account by private buyers and which led to higher prices being paid for these assets. (Quiggin, 2002. Lobbying to reduce regulatory controls has resulted in an increase in a range of risks associated with these enterprises including negative externalities and the return of monopoly inefficiencies. (Quiggin, 2002). The risk premium demanded by equity investors, typically around 6%, is not included in the return from sovereign or high quality corporate risk such as bonds. (Quiggin, 2002). The returns demanded from these privatised enterprises must now factor this in and raise prices and reduce employment to meet the market demands without any increase in economic efficiency. Some argue a pervasive fear of risk taking has led to a shift in the financial sector from raising capital to risk management. (Ben-Ami, 2001 p154). Furthermore companies welcome increasing regulation as a protection against instability. Intervention serves to protect the interests of capital against the risk they willingly assume. (Bryan, 2000). The growth in the demand for derivatives from fund managers as hedge mechanisms is also attributed to this shift from the focus on returns. (Ben-Ami, 2001 p155). In this see-sawing some of the policies that are criticised for restricting free markets are actually serving to save capital from itself. (Bryan, 2000). This confusion is not new and has been systematically employed by the state, proponents of regulation and their detractors. At various times the state has promoted the free market with a fear of the workhouse or transportation and with privatisation of common lands.(McQueen, 2000) At other times exploitation has been seen as wasteful and costly and its reduction necessary for a return to economic security. (Gordon, Weisskopf and Bowles, p259). I argue this is the dialectic of risk shifting employed by the bourgeoisie justifying the returns to capital.
The bourgeoisie are concerned with the maintenance of social stability and moral precepts under the guise of civilization; the more readily to promote naked self interest and cash payment. (Marx in Argyrous & Stilwell 2003). Class conflict or low previous capital accumulation may dispose capitalists to dispose of their profits in other ways. (Gordon, Weisskopf, and Bowles, p257) Ricardo was a successful participant in incipient stock and bond markets. He took his profits and bought land. As a result of close observation of his land owning peers he expounded a theory of crisis following from the returns to rent from productive land rising as less productive land was cultivated. (Ricardo in Argyrous & Stilwell 2003) Rents to landowners were likely to be wasted in his view. He also became concerned with the risk taxation posed to potential investors, a recurrent theme with supply side theorists ever since. (Ricardo in Argyrous & Stilwell 2003) Capitalists and supply side theorists say economic crisis is precipitated by demands for real wage increases. (McNally, 1999) Keynes suggested under-consumption and unemployment led to crisis. The Bank for International Settlements (2001) argues waves of optimism are generated from favourable developments in the real economy which leads to underestimation of risk. Workers are more concerned with the risk of unemployment and the growth of inequality in pay. (Nakamura, 2000 p25) These conflicting or supportive perceptions are blamed for crisis.
In situations of crisis, basic changes in economic and political institutions may be necessary to return to prosperity. (Gordon, Weisskopf, and Bowles, p257) National central banks and the Bank for International Settlements have become prominent in managing risk. (RBA 2004, BIS 2004) The risk of inflation and the destabilizing effect it has on economies has become the dominant preoccupation. For them inflation is the main risk (Bell, 2004) even as the expansion of debt is used to make payments on earlier debt and to bolster domestic demand in an attempt to maintain profits. (McNally, 1999) The risk of financial institution failure and the resultant contagion is being addressed with a range of capital adequacy measures. (Basel Committee Bank Supervision 1999) Increased transparency is demanded from any institution that wants to stay in the global financial market are now mandated. (BCBS 1999) The Australian Prudential Regulation Authority’s mission it to establish and enforce prudential standards so that financial promises made by institutions are kept. (APRA, 2004) The rise of consumer protection has replaced caveat emptor as a principle of business. This has led to the development of institutions like the Australian Competition and Consumer Commission and the Australian Securities Investment Commission. Access to numerous tribunals dispensing quick and cheap arbitration has replaced a monolithic court structure. The whole area of mediation in law has arrived. I suggest this has altered the landscape in the perception of risks by agents. In my opinion the range of risks has not changed, we are developing new institutions to manage them. ACCC makes sure the provisions of the Trade Practices Act for consumer protection are followed. (ACCC Journal No.43 p86) The aim is to strengthen the position of consumers relative to sellers, distributors and manufacturers by ensuring that businesses compete fairly on price and quality, and by implying into consumer contracts non-excludable conditions and warranties as to quality, fitness and title. (ACCC Journal No.43 p86) The development of behavioural economics and finance has led to insights that will influence the development of different political institutions and systems to manage risk. (Gersen, 2002) Individuals respond to social, market and government incentives in ways not necessarily in accordance with theories of rational actors. (Gersen, 2002) Regulation of the insurance industry and its interaction with individual perceptions of risk provides a good example. A previous generation of actors undertook a level of self insurance, perhaps out of ignorance, that was replaced following a wave of public liability litigation. The insurance companies left the market and it required new legislation to limit the level of damages claimable to entice them back. Legislative intervention provided subsidies to health insurance companies following the declining provision of welfare services. (Bryan, 2000). Regulatory interventions are essential to capital in periods of economic instability and increased risk (Bryan, 2000). And they go some way to protect the interests of those most at risk of pillage since the dawn of history.
In conclusion I suggest political economy sees a wider definition of risk than orthodox economics allows. Placing theories of risk in the individual, institutional and political contexts in which they evolve brings the economic rhetoric they generate into relief. From the pre-feudal need for clan survival through the development of property rights and contractual obligations into the risk shifting of modern society this paper has traced the emergence of the risk society. Particular attention has been paid to the role of the state and organised capital in forming, regulating and maintaining markets as mechanisms for privatising risk to increase the returns to the interests of capital
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