Economics in an Uncertain World

CRESPO, RICARDO F.; TOHMÉ, FERNANDO

Buenos Aires

Congreso; 17th International Congress on Logic, Methodology and Philosophy of Science and Technology; 2023

The environments in which humans live and interact are plagued by uncertainties. Their sources are manifold. Perhaps the main cause is the fact that “each person is a world”. Another relevant cause is that the future is inherently contingent, and consequently unknown and hardly predictable. Even worse, forecasts can be falsified by humans aware of them. These characteristics make extremely difficult to make inductive inferences other than for frequently repeated events. Despite these aspects are well-known, economic theory has often neglected uncertainty, trying to reduce it to probabilistically tractable risk. In the first half of the XXth century, uncertainty was considered by authors like Frank Knight and John Maynard Keynes (and much later by George Shackle) as a non-measurable phenomenon. These authors suggested alternative ways of addressing the presence of uncertain events in economic affairs. In this paper we examine how these ideas evolved in the last century. We start by analyzing in some detail the ways in which Knight, Keynes and Shackle addressed the problem of making rational choices under uncertainty, showing the similarities of their views with some aspects of the logical process of abduction. Knight, Keynes, and Shackle share a common view according to which humans analyse current situations in the light of past facts, qualitatively appraising different scenarios. While they use a mixture of abductive, inductive, and deductive procedures, abduction plays the most relevant role. The revolution in economic theory brought by the ideas of John von Neumann with Oskar Morgenstern, in particular the representation of rationality as the maximization of expected utility, called for a probabilistic treatment of uncertainties. Despite the early critiques of Maurice Allais and other continental economists, these ideas became enriched by the development of the subjective expected utility theory of Leonard Savage and the version promoted by de Finetti (1937), based on the idea of implicit probabilities exhibited by the betting odds of economic agents. Interestingly, starting in the 1970s with the experiments on decision-making of Amos Tversky and Daniel Kahneman (1971) and a renewed interest in the results of Daniel Ellsberg (1961), economists realized that economic agents in real-world situations may not be able to manage correctly the assignment of probabilities to uncertain events. The development of Behavioral Economics, intending to incorporate all the aforementioned effects into economic models, led to a large body of alternative models. A particularly interesting development is Itzhak Gilboa, Stefania Minardi and Larry Samuelson’s (2020) generalized theory-based and analogy-based model of reasoning in decision under uncertainty. In this framework agents have to choose among different world views, each one corresponding to a “theory” about an uncertain situation. The similarity with certain aspects of abduction is evident, showing that the literature of the last hundred years has come close to full circle back to the original ideas of Knight and Keynes.