All right, so we've talked about systems, we've talked about networks inside systems. What about risk? What do we mean by risk to a system? And let's explore that a little bit. Let's just first go to the Oxford English Dictionary and their definition. A situation involving exposure to danger. Okay. That's—this is a risky situation. The possibility that something unpleasant or unwelcome will happen. By the way, the other side of risk is opportunity. The possibility that something pleasant or welcome will happen. A person or thing regarded as a threat or likely source of danger. That's a risky proposition. That's a risky action. That is a risky network. Act or fail to act in such a way as to bring about the possibility of an unpleasant or unwelcome event. So risk can be risk avoidance. And this is a very interesting illustration of this. So someone playing Russian roulette and somebody says "Why do you always win?" And he says, "I play every night till I became immune." Okay. This is a way of avoiding risk in a sense by immunizing yourself, although, of course with Russian roulette that's not going to work very well. Now the combination of two things are at the heart of risk. One is the impact. Okay? How much—how bad can it be or how good can it be? And the second is the probability of it happening. So let's say you've got something that's very improbable. Okay? And even if it happens, eh, it's okay. Now that's going to be very different than if you have something which is low impact. Okay? But actually, the probability is pretty high. So even if it has low impact, you're probably going to change your behavior in some way or another. Let's look on the other side. And, of course, the medium is somewhere in the middle. High impact. Let's say there's a low probability but there's quite a bit of— the consequences are really, really high. So even though this likelihood is low that this is going to happen, if it does happen it could be really bad. Or again, really, really good. The red zone is that area which is high probability. Something that's likely to happen and the impact is meant to be high. Okay? And we can do this—decision trees are a little bit about this, where you look at the probabilities and their return. How bad can it be and how likely will it be to happen? That's at the very core of risk. Now risk is also associated with bounded rationality. Bounded rationality is a concept that says we don't know everything. That's first of all. Some things may be impossible to know. There might be some things that we'll just never know. We cannot process all the information. Even if we got to know everything, we simply don't have the time to process all. And we also don't have infinite time to make decisions. You can't sit there trying to go through this particular schema every single time you step out the door. We do this somewhat subconsciously, okay, and we do take this into account. But we don't do it constantly because we would just be exhausted. Moreover, in the words of Donald Rumsfeld, "There are some known knowns; these are things that we know." Okay. And you can plan your life this way. "There are known unknowns." Things that you say, well, you know, I don't know what's going to happen here so I'd better be a little bit careful. And then there's the really, really risky element, if you will. They are the "unknown unknowns." Things that you don't know that you don't know. Okay? In the immortal words of Mark Twain, it's not what you don't know that will get you. It's what you know but just ain't so. All right? And you always have to be worried that that knowledge you might have may not be correct and it might not be all that you need. Now it's also important to distinguish between risk and uncertainty. In some ways, we should call this "global systemic uncertainty." That didn't work very well so we adopted "risk." But it's very important to distinguish between risk and uncertainty. And here we go—we follow the work of Frank Knight. Risk is "measurable uncertainty." Risk is when you know enough and you've got the ability to actually give a number. Okay? Uncertainty is a very different thing. Uncertain is you simply don't know. You don't know what the risk might be. And a possible source of systemic fragility is confusing the two— is when we come to believe that the uncertainties in life can be quantified, that we can actually come up with a decision tree if you will. That we can design an efficient system to such an extent that we can avoid risk or we can optimize the result. But there's always uncertainty. So proceed under the assumption that systemic risks we discuss are not necessarily unquantifiable uncertainties in the Knightian sense of uncertainty. All right? That risk is— it refers to actually knowing about the probability of something. Uncertainty gives you that much more accurate and, if you will, much more relevant idea of what is really going on. Risk is relative. Okay? And it's relative in different ways. First of all, different people can live with different sources of risk. If any of you have ever had a brokerage account, one of the things that they ask you to do is to answer a question of ten—a set of ten questions to see if you are risk tolerant or risk intolerant, et cetera. So individually, we're going to be very opposed to it. What society considers risky is often based on who might experience it. So we might prize a danger occurring to a certain part of the population more than we prize the danger going to another part of the population. Risk is very much tied to power. Okay? Risk can be a reflection of power. One of the ways we can define wealth, okay, is your ability to push away risk or push away uncertainty. One of my definitions of poverty or the cost of poverty is anxiety or uncertainty. If you're poor, you don't know— you can't afford uncertainty because you don't have the resources. If you're wealthy, maybe you can afford more uncertainty simply because you've got more in the bank, as it will, to pay for any kind of situation that you might have. Who takes the risk is not always who pays for the risk. So when we're talking about globalization, let's go back to what we were saying that globalization is good and bad depending on where you are. The risk of globalization might be very, very different depending on where you sit. This is a map of Los Angeles. Your—the risk of you suffering from an earthquake or suffering from some natural element is going to be different across the city and very likely that those parts that are riskier—that are the riskiest— are going to be the poor ones. So again, risk is not absolute. Risk, we might describe risk or uncertainty as uncertainty to a particular person or to a particular individual, to a particular firm. All right? It is not this absolute. The only way it can be absolute is if we talk about truly existential risk. What is the risk of the earth exploding, for example, where it involved everybody. Okay? But most of the time, risk is very, very individualized or personified, depending on where you sit in a social structure. And one of the things that we know is that the richer or the more powerful you are, a) the less uncertainty there can be in your life, and b) the better resources you have to deal with that uncertainty. We also know that the risk or uncertainties of the very powerful, of the very rich, of those who claim to be on top of the society, they're taken much more seriously. And, again, there's lots of discussions about this. For example, the amount of money that flows into certain diseases and that money is very correlated with who is likely to get that kind of disease. The diseases that a particular ethnic group or particular class might get, if they're not highly esteemed or they're not high in the hierarchy, that kind of disease is going to get a lot less attention than a disease that affects the rich and famous, as it were. Risk is also historical. We live in a risky—in a new risky world. This is from a wonderful book by Emily Nacol, An Age of Risk, where she says that contemporary life is defined by risk. By contemporary, let's say from beginning with the Enlightenment, with the 18th century. "In human beings, in their conduct, in their liberty, in the relations between them, and in the fact of their association, in society." We live in a much more uncertain world than we did, let's say, prior to the 17th century. The notion of an unknowable future. Our certainty about what is coming, our ability to place bets, in some ways, has changed. Where previously future was either certain and unchanging or either the "realm of fate, fortune, or providence"—hey, completely exogenous— Now we live in a world where we live with a lot of endogenous uncertainty. And modern institutions: government, organizations, are often built—if we think of governance. If we think of what the rule of governance is, one of them is ways of reducing uncertainty or dealing with the capacity to deal with negative consequences or negative events. So risk, again, I want you to think about this, or uncertainty, to use the more accurate word, it's relative. It's relative to who you are and it's relative where you sit and it's relative to what time. And we live in this way with all our new technology, all our new wealth, all our new opportunities, we live in some ways, in some ways, in a riskier world. So what are the sources of this risk? Where does this risk come from? Why do we live with this risk? And we'll turn to that next.
