Recognizing Known Unknowns Helps us to Adapt to Climate Change

I like Peter Coy’s new New York Times column and want to use it to discuss the climate change adaptation challenge.

Here is a direct quote from Coy;

“Knight’s thinking is as relevant now as it was in 1921, when “Risk, Uncertainty and Profit” was published. We still need tools for coping with uncertainty. Knight’s perspective can guide us to a middle course between trying to avoid uncertainty entirely, which is impossible, and plunging headlong into the darkness, which is reckless.

Knight has been forgotten or misconstrued repeatedly over the past century. A new book by the scholar Amar Bhidé brings back his original insights and dares to try to improve upon them — mostly by extending them into realms that Knight didn’t consider, such as the persuasive techniques that entrepreneurs use to overcome the uncertainty felt by investors, customers and partners.”

Peter Coy has not interviewed me about my work on Knightian Uncertainty applied to climate change adaptation. In my academic writing and in my 2021 book Adapting to Climate Change,

I discuss the power of imagination in helping us to adapt to climate change. Think of John Lennon and Yoko Ono’s song Imagine. Those who can imagine scenarios that have never happened before are more likely to build out contingency plans to protect themselves and their families. For example, if one fears that wildfire smoke is becoming a worse problem in the American West then one makes plans to upgrade one’s windows and one searches Amazon to buy an air purifier. As more of us are aware of our own uncertainty about risks that climate change poses, we build in ways to protect ourselves. Work from Home is such a real option that allows one to keep one’s job but to work from anywhere during a local crisis. This is just one of the many examples I discuss in the book.

As more of us are aware of the “known unknowns” regarding climate change risks, those of us who are risk averse seek out products to protect us. As this aggregate demand for defensive products rise, entrepreneurs have a profit incentive to design these. In this sense, when we act upon the nagging feelings of our ambiguity aversion this helps everyone to adapt because when we “vote with our pocketbook” and demand defensive products, capitalists get to work to sell these!! This is the Boskin Report’s optimism applied to climate change adaptation!

To wrap up, there are “unknown unknowns” and there “known unknowns”. Over time, we learn and we become afraid. We make both Type 1 and Type 2 errors here.

A Type 1 Error is to face a threat that we dismiss as a nothing!

A Type 2 Error is to overreact to a non-threat.

I claim that a “Silver Lining” of the New York Times and Greta lecturing us every day that the world is ending due to climate change and the behavior of regulated insurers as they raise rates and cancel service is that more and more Americans are aware that they know that they do not know the actuarial risks that climate change poses. This is 2025 Knightian Uncertainty. Faced with this reality, we seek market solutions to protect us. Some of us may overdo it as we “bubble wrap” our families in the name of keeping them safe. This will lead to Type 2 errors. Yes, in retrospect some of us may “overspend” on precautions but if this gives us peace of mind this isn’t such a big deal.

We would face more danger if we unhumble and declare with certitude that we face no risks when in fact we may. The humble person knows what she does not know and proceeds accordingly.

Coy’s piece would be even stronger if he applies these ideas to the climate change adaptation challenge.