Knowledge And Decisions

Each individual is of course an expert on his own degree of aversion to risk, and knows how much he wants to put aside for a rainy day, and roughly how he wants to distribute those savings as between cash in his pockets, deposits in an insured bank account, payments into a pension plan, investments in low-risk bonds, or speculation in oil or commodity futures. (For most people, zero is the amount that they are willing to risk on the last two activities.) On the other side of the market are numerous people who are knowledgeable about the specific techniques of producing specific things — that is, people who have the most accurate knowledge of just how risky particular ventures happen to be and what payoffs could be reasonably expected. In other words they know how much they can afford to pay in return for the use of resources needed to carry out their economic activities. They will try to pay as little as possible, just as creditors or investors will try to get as much as possible, but each knows how far he is prepared to go in a given direction. Each is an expert in his own situation, however little he may know about the other’s situation, and the process of haggling for a deal — either directly or through such intermediary institutions as banks, insurance companies or mutual funds — is essentially a communication of social knowledge, each fragment of which originates with the individual who is in a position to know the most that is known on his tiny part of the subject.

This knowledge is never perfect, nor can it be, regardless of the kind of political or economic institutions in a particular country. From this process emerges a sorting out of those activities involving the least risk, being financed (at lowest costs) by those least willing to bear risks and most willing to leave the big payoffs to those ready to take big gambles. This need not involve direct individual investment in specific economic enterprises, and usually does not. Incoming funds (savings deposits, insurance premiums, etc.) are pooled by intermediary institutions and the overall risks reduced further by spreading the investments around in numerous, relatively safe, ventures which pay modest amounts for the use of the money to buy the resources they need. Although the transactions are usually between impersonal organizations, the very personal aversion to risk of those supplying the money is the controlling factor. A bank cannot bounce a depositor’s check for his rent because the bank itself has “insufficient funds,” due to risky investments that did not work out. An insurance company cannot refuse to pay for a policy-holder’s operation or funeral because the oil drilling it financed did not turn up any gushers. Any such result in these kinds of institutions — patronized by people averse to risk — would bring on the immediate destruction of the financial institution itself, and probably criminal investigation of its officials. On the other hand, nothing nearly as dire happens when a corporation reduces (or skips) a dividend payment to its stockholders, whose risk taking is understood by all to be part of the reason why they receive dividends at all. And for people investing in wildcat oil drilling operations, there may not be much likelihood of their getting anything at all on any predictable date, and with only the hope of a magnificent payoff now and then. In short, though these various financial organizations have no feelings, their behavior is constrained by the different feelings of those who supply their respective investment funds.

No single individual, nor any collection of individuals, could have in their heads all the complex technical information on production processes and the nuances of personal feeling involved in matching millions of investment sources and users. The most efficient and imposing bank, corporation, or government bureau has only scratched the surface. The astronomical amount of knowledge in the whole system is sorted and coordinated in fragments by the simple process of each transactor seeking the best deal from his own subjective viewpoint and not necessarily (or even usually) by knowing why the deal that suits him best emerged as it did from the millions of other possibilities in the market.