Against the Gods: The Remarkable Story of Risk (45 page)

In 1937, in response to criticisms of The General Theory, Keynes
summed up his views:

By "uncertain" knowledge ... I do not mean merely to distinguish
what is known for certain from what is only probable. The game of
roulette is not subject, in this sense, to uncertainty.... The sense in
which I am using the term is that in which the prospect of a European
war is uncertain, or the price of copper and the rate of interest twenty
years hence, or the obsolescence of a new invention.... About these
matters, there is no scientific basis on which to form any calculable
probability whatever. We simply do not know!3s

A tremendous idea lies buried in the notion that we simply do not
know. Rather than frightening us, Keynes's words bring great news: we
are not prisoners of an inevitable future. Uncertainty makes us free.

Consider the alternative. All the thinkers from Pascal to Galton told
us that the laws of probability work because we have no control over the
next throw of the dice, or where our next error in measurement will
occur, or the influence of a static normality to which matters ultimately
revert. In this context, everything in life is like Jacob Bernoulli's jar: we
are free to pull out any pebble, but we cannot choose its color. As
Laplace reminded us, "All events, even those which on account of their
insignificance do not seem to follow the great laws of nature, are a result
of it just as necessarily as the revolutions of the sun."36

This is, in short, a story of the inevitable. Where everything works
according to the laws of probability, we are like primitive people-or
gamblers-who have no recourse but to recite incantations to their
gods. Nothing that we do, no judgment that we make, no response to
our animal spirits, is going to have the slightest influence on the final result. It may appear to be a well-ordered world in which the probabilities yield to careful mathematical analysis, but each of us might just
as well retire to a windowless prison cell-a fate that the flutter of a
butterfly's wings billions of years ago may have ordained in any case.

What a bore! But thank goodness, the world of pure probability does
not exist except on paper or perhaps as a partial description of nature. It
has nothing to do with breathing, sweating, anxious, and creative human
beings struggling to find their way out of the darkness.

That is good news, not bad news. Once we understand that we are
not obliged to accept the spin of the roulette wheel or the cards we are
dealt, we are free souls. Our decisions matter. We can change the
world. Keynes's economic prescriptions reveal that as we make decisions we do change the world.

Whether that change turns out to be for better or for worse is up
to us. The spin of the roulette wheel has nothing to do with it.

e have just witnessed Frank Knight's determination to elevate uncertainty to a central role in the analysis of risk and
decision-making and the energy and eloquence with which
Keynes mounted his attack on the assumptions of the classical economists. Yet faith in the reality of rational behavior and in the power of
measurement in risk management persisted throughout all the turmoil
of the Depression and the Second World War. Theories on these matters now began to move along sharply divergent paths, one traveled by
the followers of Keynes ("We simply do not know") and the other by
the followers of Jevons ("Pleasure, pain, labour, utility, value, wealth,
money, capital, etc. are all notions admitting of quantity.")

During the quarter-century that followed the publication of Keynes's
General Theory, an important advance in the understanding of risk and
uncertainty appeared in the guise of the theory of games of strategy. This
was a practical paradigm rooted in the Victorian conviction that measurement is indispensable in interpreting human behavior. The theory
focuses on decision-making, but bears little resemblance to the many
other theories that originated in games of chance.

Despite its nineteenth-century forebears, game theory represents a
dramatic break from earlier efforts to incorporate mathematical inevitability into decision-making. In the utility theories of both Daniel
Bernoulli and Jevons, the individual makes choices in isolation, unaware of what others might be doing. In game theory, however, two or
more people try to maximize their utility simultaneously, each aware of
what the others are about.

Game theory brings a new meaning to uncertainty. Earlier theories
accepted uncertainty as a fact of life and did little to identify its source.
Game theory says that the true source of uncertainty lies in the intentions of
others.

From the perspective of game theory, almost every decision we
make is the result of a series of negotiations in which we try to reduce
uncertainty by trading off what other people want in return for what
we want ourselves. Like poker and chess, real life is a game of strategy,
combined with contracts and handshakes to protect us from cheaters.

But unlike poker and chess, we can seldom expect to be a "winner"
in these games. Choosing the alternative that we judge will bring us the
highest payoff tends to be the riskiest decision, because it may provoke
the strongest defense from players who stand to lose if we have our way.
So we usually settle for compromise alternatives, which may require us
to make the best of a bad bargain; game theory uses terms like "maximin" and "minimax" to describe such decisions. Think of seller-buyer,
landlord-tenant, husband-wife, lender-borrower, GM-Ford, parentchild, President-Congress, driver-pedestrian, boss-employee, pitcherbatter, soloist-accompanist.

Game theory was invented by John von Neumann (1903-1957), a
physicist of immense intellectual accomplishment.' Von Neumann was
instrumental in the discovery of quantum mechanics in Berlin during
the 1920s, and he played a major role in the creation of the first
American atomic bomb and, later, the hydrogen bomb. He also invented the digital computer, was an accomplished meteorologist and
mathematician, could multiply eight digits by eight digits in his head,
and loved telling ribald jokes and reciting off-color limericks. In his
work with the military, he preferred admirals to generals because ad mirals were the heavier drinkers. His biographer Norman Macrae
describes him as "excessively polite to everybody except ... two longsuffering wives," one of whom once remarked, "He can count everything except calories."2

A colleague interested in probability analysis once asked von
Neumann to define certainty. Von Neumann said first design a house and
make sure the living-room floor will not give way. To do that, he suggested, "Calculate the weight of a grand piano with six men huddling
over it to sing. Then triple that weight." That will guarantee certainty.

Von Neumann was born in Budapest to a well-to-do, cultured,
jolly family. Budapest at the time was the sixth-largest city in Europe,
prosperous and growing, with the world's first underground subway. Its
literacy rate was over 90%. More than 25% of the population was
Jewish, including the von Neumanns, although John von Neumann
paid little attention to his Jewishness except as a source of jokes.

He was by no means the only famous product of pre-World War I
Budapest. Among his contemporaries were famous physicists like himself-Leo Szilard and Edward Teller-as well as celebrities from the
world of entertainment-George Solti, Paul Lukas, Leslie Howard
(born Lazlo Steiner), Adolph Zukor, Alexander Korda, and, perhaps
most famous of all, ZsaZsa Gabor.

Von Neumann studied in Berlin at a leading scientific institution
that had considered Einstein unqualified for a research grant.' He went
on to Gottingen, where he met such distinguished scientists as Werner
Heisenberg, Enrico Fermi, and Robert Oppenheimer. During his first
visit to the United States, in 1929, von Neumann fell in love with the
country and spent most of his subsequent career, except for extended
periods working for the U.S. government, at the Institute for Advanced
Study in Princeton. His starting salary at the Institute in 1937 was
$10,000, the equivalent of over $100,000 in current purchasing power.
When Einstein joined the Institute in 1933, he had asked for a salary of
$3,000; he received $16,000.