What’s the difference between risk and uncertainty?

According to economists, risk is the known unknown; uncertainty is the unknown unknown. Put it in another way, risk is measurable while uncertainty is unmeasurable.

To a bank, liquidity risk or the risk that it will run out of cash to service deposit withdrawals, can be measured, taking into account the liquid or near-liquid funds it holds in reserves, the average size of deposits, the profile of its depositors, its borrowing limit with the BSP, and so forth.

However, an event like a tsunami hitting Metro Manila due to an earthquake in Manila Bay that creates financial panic is an unmeasurable unknown. The famous trader, statistician, and risk analyst Nassim Taleb would call this kind of events, “black swans” or rare, high-impact and unpredictable events. One can even say that the lightning that hit Roberto Ongpin, whom President Duterte called an oligarch, is a black swan.

Risk can be managed, uncertainty cannot. Thus, businessmen hate uncertainty. They can prepare or hedge against risk, but not uncertainty.

In this light, while businessmen welcome the initiatives of President Duterte, such as his tough and swift crackdown on illegal drugs, they also fear the uncertainty. This is because of President Duterte’s unconventional, out of the box, unpredictable approach.

For example, dispensing with niceties and formalistic application of due process, President Duterte uses an unconventional “name and shame campaign” against those he perceives as enemies of the state. He makes strategic use of intelligence to “shock and awe” his opponents.

There may be a method to his madness.

As a former prosecutor, he knows very well the limits of the criminal justice system in the Philippines where judges can be bribed, policemen fail to appear as witnesses, or even when the perpetuators are found guilty and jailed, continue their nefarious activities behind bars. He also knows that traditional media are controlled by “oligarchs” and that a number of media personalities can be bribed. Hence, to keep his enemies off-balanced, he resorts to preemptive strikes of naming and shaming. He’s helped by his legion of passionate followers in social media critics call Dutertards.

However, while this unconventional style may be effective, it also breeds uncertainty costs. While businessmen are applauding the peace and order that the anti-drug campaign will bring, lurking at the back of their minds is the thought that they could be the next Roberto “Bobby” Ongpin. If strategic intelligence and naming and shaming can be brought against Leila de Lima, would it also be used against them, especially if they had supported Duterte’s political opponents?

It’s not only in the area of the tough anti-drug war that uncertainty casts a pall over investments. This is because Duterte is some kind of revolutionary disrupting the old order established by the Cory Constitution.

Take federalism, for example, which is Duterte’s solution to the overcentralized, dysfunctional, unitary government created by the 1987 Constitution. The hope is that federalism will bring resources and government closer to the localities, especially the far-flung regions. The flip side of that, however, is that the federal states may be controlled by the likes of Pangasinan Congressman Amado Espino, Jr., a former governor and alleged billionaire drug lord, according to President Duterte.

There are also many unknowns as to what the Philippine Federal state will look like, from the powers that will be devolved to the type that will eventually be approved (federal-parliamentary? Federal-presidential? Unicameral? Two Party or multi-party system?, etc.)

Meantime, will businessmen, foreign and local, make large, long-term commitments in the face of this uncertainty? Since the administration policies are still evolving and the programs are unpolished, there are lots of uncertainty in other areas of the economy as well.

The mining industry doesn’t know if there’s such a thing as responsible mining in the vocabulary of the administration. Will open pit mining be banned, whether it’s done in accordance with Australian or Canadian environmental standards or not? Will coal mining be prohibited and will our energy sector be made dependent on intermittent, costly renewable energy? We simply don’t know.

The Duterte administration’s campaign against “endo” or the practice of firing contractual workers before they enjoy security of tenure is also fostering uncertainty. Will all forms of contract employment be banned as the leftist organizations want? A good question since the Undersecretary of Labor came from a leftist organization. Indeed, there are reports that labor inspectors are terrorizing SMEs and even PEZA enterprises on the question of “endo labor.”

The same uncertainty hangs over the agriculture sector.

Department of Agrarian Reform (DAR) Secretary Rafael Mariano is threatening to undo all previous conversion approvals from agricultural to industrial use. He’s also proposing another Agrarian Reform law that will extend uncertainty over property rights to agricultural land. Investors in the countryside will surely hold back if the agricultural land they will acquire will be subjected to land reform. Also, the DAR seems bent on breaking up lands into atomized units. This means agribusiness would have no place in a Duterte economy.

The one exception to the uncertainty over the administration’s policies is the tax reform plan unveiled by the Department of Finance. The tax reform plan is detailed. Specific reforms are enumerated to either make taxes more progressive or penalize negative externalities (raising taxes on fuel, sugary drinks, and junk food). The principles are also clearly spelled out: progressivity, competitiveness, expanding the tax base, fairness, simplicity and ease of compliance.

Thus, there are no uncertainty costs when it comes to tax reform. While certain industries will get hit, there’s enough overall benefit that investors won’t get discouraged and enough specifity, so that investors won’t have to second guess what the administration will do.

To repeat, risk is knowable; uncertainty is not. Getting slapped with higher taxes is a risk; ending up in President Duterte’s shame list is an uncertainty. The very nature of the Duterte presidency — disruptive, unconventional, unpredictable, swift, and radical change — will result in more uncertainty.

Therefore, the economy will continue to post strong growth on the back of OFW remittances, low oil prices, and healthy BPO revenues. Higher infrastructure spending, which the administration promises will rise to 7% of GDP, will further boost growth.

However, uncertainty costs will prevent the economy from reaching its full potential. The reduction in uncertainty costs and the flowering of the economy will only happen after President Duterte has delivered on his promised revolution.

Source: www.bworldonline.com