What Is a Riskless Society?
In economic theory, a riskless society is one of the assumptions underlying the Arrow-Debreu general equilibrium theory. Markets are assumed to be complete and sophisticated enough that every imaginable risk can be mitigated by insurance. Economists Kenneth Arrow and Gerard Debreu developed the notion of a riskless society as a means to simplify their model by abstracting risk out of the theory. More broadly, a riskless society (or a world without risk) has been an idealized and elusive goal of risk management through financial sophistication or through government regulation.
- The riskless society is one of the background assumptions in modern general equilibrium theory.
- Arrow-Debreu general equilibrium theory assumes a world in which all risk is insurable, so that risk and uncertainty can be ignored in constructing their model.
- In a more general sense, the idea of a riskless society can be conceived as a general goal of risk management, financial and insurance markets, and government regulation.
Understanding a Riskless Society
The modern concept of general equilibrium as developed by Kenneth Arrow, Gerard Debreu, and others in the 1950s attempts to explain the complex interactions between commodity supply, demand, and prices across multiple interconnected markets. In 1972, Arrow was a co-recipient of the Nobel Memorial Prize in Economic Sciences. Debreu was awarded the Nobel Prize for his work in equilibrium theory in 1983.
In their theory, markets are assumed to be complete, or in other words, markets function with no transactions costs and perfect information and that for any economic good, a market exists where that good can be traded in order to balance the underlying forces that drive supply and demand and create a market price for that good. This includes markets for insurance (or the financial management of risk); for any type of risk, a market exists to provide insurance to fully manage that risk. This assumption greatly simplifies the mathematical derivation and expression of their theory, because it eliminates the need to explicitly model any risk, uncertainty, or probabilistic outcomes for any of the economic phenomena that the model incorporates or seeks to explain.
The theory is a mathematical model based on a perfectly competitive markets, and therefore it does not necessarily align with the way that economies are structured and function in the real world. Critics of the riskless society model argue that equilibrium theory stands in opposition to much of the empirical evidence the markets provide us with. They argue that the riskless society model does not adequately take into account rare events, such as catastrophes. Furthermore, it does not address the role that fear or other emotions may play in influencing decision-making. Modern behavioral finance theory attempts to study markets under states of non-equilibrium.
In the real world, risk happens and markets for insurance are not complete. The quest to manage financial, personal, and other types of risk has spawned major markets for insurance and derivatives, non-market-based institutions to share risk, and vast bodies of government regulation to prevent people from taking certain risks or bail them out when risks go bad.
Since Arrow and Debreu's work was first published, the prevalence of financial derivatives products has grown exponentially. However it may simply not be possible to actually insure all risk, and some have even argued that attempting to do so only magnifies long-term catastrophic risk when the risk management tools themselves fail. Complex financial instruments that were presented as mitigating risk, including derivatives, played a contributing role in the 2008 financial crisis and Great Recession.
Other Meanings of Riskless Society
The term riskless society is also used outside the specific domain of theoretical economics. Often, it is a phrase that comes up in discussions of regulation, risk, and public safety. Lawmakers and administrators may implement increased rules and regulations aimed at protecting public health or preventing accidents, in the aim of minimizing societal risk. Examples of such policies might be statewide requirements that motorcyclists wear helmets or that limit hazardous chemicals in the workplace. Critics of such regulation argue that a riskless society is an impossibility, and that additional rules impose an unnecessary burden while constraining people's ability to make free choices.