Davidson’s Swans & Knight

 Paul Davidson BLACK SWANS AND KNIGHT‟S EPISTEMOLOGICAL UNCERTAINTY: ARE THESE CONCEPTS ALSO UNDERLYING BEHAVIORAL AND POST WALRASIAN THEORY?  Journal of Post Keynesian Economics, vol. 32,  pp. 567-570, 2010.

Abstract

This note argues that Taleb‟s “black Swan” argument regarding uncertainty is equivalent to Knight‘s epistemological concept of uncertainty. Moreover both Behavioral economists and Post Walrasians use an epistemological concept of uncertainty. This view differences significantly and immensely from Keynes’s idea that uncertainty is an ontological concept.

Body

Knight suggests that any lack of knowledge about external reality that might be attributed to a lack of real consistency over time in the cosmos is insignificant and may be ignored when compared to humans’ cognitive failures to identify a predetermined external (ergodic) reality of “unique” events.

In the long run, those entrepreneurs who in their price – marginal cost calculations include these insurance costs “as if” they knew the objective probabilities implicit in Knight’s unchanging reality will make the efficient decision and will, in Knight’s system, earn profits. These are the Darwinian entrepreneurial agents who know how to build robustness in the market system that are the heroes of Taleb’s (and Knight’s) view of the economy.

Behavioral theorists can not explain why those who undertake classical non-rational behavior have not been made extinct by a Darwinian struggle with those real world decision makers who take the time to act rationally or who, at least, make decisions that are consistent with those they would make “as if” they knew the underlying Walrasian system.

Had behavioral theorists, Post Walrasians and Taleb adopted Keynes’s general theory as their basic framework, irrational behavior can be explained as sensible behavior if the economy is a non-ergodic system. Or as Hicks (1977, p. vii) succinctly put it, “One must assume that the people in one’s models do not know what is going to happen, and know that they do not know just what is going to happen.” In conditions of true uncertainty, people often realize they just do not, and can not, possess a clue as to what rational behavior should be.

Comments

Most of the time Knight’s focus on assessing current realities seems reasonable if one is only concerned with the short-term, and I agree that Taleb’s ‘Black Swans’ could be interpreted as simply important but rare probabilistic events. At least, Taleb does not seem to steer us firmly away from such an interpretation.

If Knight is right then – as Davidson points out – we ought to be getting better at economics and crashes less serious and frequent. On the other hand, if there can be genuine change, and even innovation building on innovation, then it could be that we get worse, and crashes more serious and frequent, or anywhere in between. It is not obvious which is the case, and we now regard as foolish those who thought that there would be no more change. So even if Knight is now right, how can we know that he is right? Is it not more reasonable to suppose that he might not be?

But I diverge from Davidson as concerns rationality. Some hold that we do not have a clue as to what rational behaviour would be in the face of uncertainty, so we may as well ignore it. It seems to me that the conventional concept of rationality is actually inappropriate in the face of uncertainty, and that there is no one ‘correct’ solution. But, as Keynes indicated, we may nevertheless be able to behave more reasonably than Knight suggests. (For which, see Davidson, or this blog!)

See Also

My notes on Rationality and uncertainty. Other work by Davidson.

Dave Marsay

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