Rethinking Economics, the Role of Insurance: Adam Smith Upside Down—The Central Role of Insurance in the New Post-Industrial (Service) Economy

Services are becoming increasingly important within every phase and aspect of manufacturing activity such as control, design, planning, financing, security and safety, which are essential for storage, distribution, logistics and maintenance.
The outcome of systems and products is measured with respect to time. Here it is the UTILISATION value that is important, which is based on real PERFORMANCE for a PERIOD of time. The utilization value of a physical product depends on both its utility, its lifespan, the liabilities for service and repair. The utilization value of a service such as education may depend on its relevance for employment or productive application. The last step involves disposal, an ex-post production cost. The length of time projected into the future is by definition uncertain. The magnitude of the value is subject to uncertainties regarding lifespan, service and warranty costs, product liability, etc. Furthermore, even the best estimate of this period can be reduced by any sort of accidents or unanticipated interruption. Uncertainty and risk are therefore the rules of the game in the modern “service” economy.

This reality conflicts with the idea held by many that the enormous advances in research should make reality more and more defined, predictable and foreseeable. This is simply not true, which appears paradoxical. If economic value is linked to performance in time, the future remains at least in part unpredictable. Many insurers themselves believed once that because of science, the market of insurable risks would disappear, as a result of the anticipated increase in predictability. The opposite has happened: the market for insurable risks is constantly increasing.

There is also another basic reason well understood by engineers. As technology advances, the margins of error possible in any operating system producing destructive results tend to get more and more reduced. In an automobile one can drive with open windows, but what about in the airplane? Moreover, as the Fukushima nuclear accident, the BP Gulf of New Mexico oil rig accident and recent launch failures by SpaceX so dramatically illustrate, giant technological performances tend to produce what are referred to as uninsurable risks.

It is also important to understand that the risks linked to the vulnerabilities of systems implicitly interconnected with the environment where one operates are not of the same kind as the so called entrepreneurial risks. One can take or refuse to take entrepreneurial risks, but the risks related to system vulnerability are unavoidable “acts of God”. The notion of Risk Management today has to take into account two types of risk which are often confused: entrepreneurial risks and “pure risks”.

Since the time of the industrial revolution, insurance has been traditionally considered as secondary. At best it was sometimes wrongly identified with banking and finance. If an automobile company does important investments and financial activities, it still remains an automobile company. However, today insurance is at the center of the service economy, concerned with performance in time. Insurance is a necessary and an indispensable gear for the functioning of the modern world economy which reflects the centrality of risk and uncertainty in the modern service economy and the need for a serious reevaluation of many prevailing tenets of Economics.

It is essential to remember that for over a century after Smith, knowledge of economics was considered a dispensable luxury. The emphasis after Smith was on the supply side, on how to produce wealth. During and after Keynes, it has been concentrated on the demand side (first in its solvable version, and then extended more and more into its insolvable version, hence the present financial crisis). The service economy requires an equal understanding of the supply side as well.

The present indicators of the “value added” economy such as the GNP measure both positive productive activities and negative destructive activities such as war as if they were of similar and equal value. Instead a vital distinction needs to be made between positive contributions to wealth and the cost of conservation, remediation and recovery from natural disasters which do not reflect positive contributions to economic welfare. These costs should be deducted rather than added to GDP. Obvious examples of deducted value are the cost of disposal of wastes and controlling pollution. On the other side, advances in technology/ communications have resulted in many performance enhancements which are only partly accounted for by the “value added” system of accounting. The contribution of IT to the wealth of nations is largely underestimated (in particular in mobilising non-monetarized contributions). It is clearly obvious that the accounting of the wealth of nations has to be deeply revised.
I have suggested in various publications two main possibilities. The first is to adopt indicators integrating economics with other social disciplines (sociology, demography, psychology, etc.). The other—remaining exclusively within the field of monetarized systems, but adopting the definition of utilisation value in the service economy—is to use the analogue methods of calculation or evaluation employed by insurance companies to ascertain the value of future events, for which they collect a premium that takes uncertainty into account.

In the older industrialized countries there are daily hundreds of articles and papers written in the hope of achieving a new wave of “traditional” growth soon: the optimists mention 2 or 3%, within essentially the same traditional system of reference (the classical industrial revolutionary perception). No vision has yet emerged of something practically and intellectually stimulating. The future has something much better under preparation, providing us with the opportunity now to rethink economics for a new, better understanding of the Wealth of Nations. All this depends on our upgrading our understanding of insurance.

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