Frank Knight, risk and uncertainty
In this article, I wish to introduce the reader to the theory of entrepreneurship advanced by Frank Knight (1885-1972), and show that the common, everyday work of the physician could be considered a form of entrepreneurial activity in the Knightian sense.
Knight was an influential American economist. He is best known for his book Risk, Uncertainty, and Profit in which he proposed to distinguish risk and uncertainty as follows:
Risk pertains to situations where outcomes occur with a frequency that is quantifiable according to probability distributions.
Risk may be mathematical and a priori knowable, meaning that the probability function that governs the outcome is known with certainty, as in the case of a coin toss (assuming the coin to be well balanced).
Risk may also be statistical, where the outcome can be estimated according to an empirically discoverable probability function. This is the case in situations where we know the set of possible outcomes and can make observations under controlled conditions to determine the probability of occurrence of each outcome.
Uncertainty, on the other hand, pertains to situations where the probability of an outcome cannot be quantified in any meaningful way. The situation is such that we don’t even know the set of all possible outcomes, let alone what numerical probabilities to assign to those outcomes. Knight believed that most situations involving human beings fall under that category of uncertainty.
Knight’s great insight was to recognize that the economic role of the entrepreneur is to shoulder uncertainty. He does so not by calculating risk, but by exercising judgment. And, as Professor Peter Klein has noted, the entrepreneurial judgment is not “contractable,” because the entrepreneur cannot articulate his belief about uncertainty in a way that can be communicated and become subject to market exchange. Instead, the economic entrepreneur must directly invest in material resources and modify them for productive use.
It is in this direct involvement with resources that the entrepreneur shoulders the uncertainty and communicates his or her judgment. Of course, some risk calculation may take place and be taken into account if the entrepreneur has some knowledge of the probability of certain outcomes, but the entrepreneurial action is ultimately in the entrepreneur’s direct investment in the resources at hand. A correct exercise of judgment returns an entrepreneurial profit, while an error in judgment incurs a loss.
Medical uncertainty and the physician
Are medical situations good examples of Knightian uncertainty? One the one hand, we may all agree that each human being is unique, unpredictable, and unrepeatable. On the other hand, much of medical practice is now guided by predictive analytics, by the examination of risk factors, and by the calculation of probability for certain outcomes, determined through ever more sophisticated epidemiological studies and clinical trials. And the use of predictive analytics is now sanctioned by “pay-for-performance” schemes to entice doctors to treat according to statistically-based algorithms.
Has modern outcomes research conquered Knightian uncertainty and provided clinicians with reliable statistical models with which medical treatment can be determined?
I don’t believe it has. How could it?
George is in my office and I ponder whether he should take a statin drug to manage his cholesterol and future risk of a heart attack. The studies that I should rely upon to make my decision have not enrolled George, of course. At best, they have enrolled someone “like” George: same age, gender, baseline blood cholesterol level, blood pressure, and perhaps a few other traits.
In other words, the claim of “likeness” that should convince me to apply statistical probabilities to George requires me to turn George into a stick figure of risk factors, a “profile,” an abstraction that overlooks everything else about him that makes him George and not someone else.
Perhaps George will respond well to the drug, or perhaps he will not. As far as his personal outcome is concerned, the statistics are meaningless.
And this is not news to statisticians. Richard von Mises (Ludwig von Mises’ younger brother), a renowned mid-twentieth century Harvard statistician, put it in no uncertain terms:
We can say nothing about the probability of death of an individual even if we know his condition of life and health in detail. The phrase ‘probability of death’, when it refers to a single person, has no meaning at all for us.
Is there no meaning and value, then, in the clinical trials and large epidemiological studies? Of course, there is. Those studies do provide useful information about the frequency at which certain outcomes occur–good or bad. Those outcomes are the ones that the study designers have chosen to record and tally.
But when applied to the patient, such epidemiological information is limited and cannot determine the course of action to take. There is much inherent residual uncertainty.
Are doctors then paralyzed or impotent in the face of the unknowable future?
Of course not, and that’s where Knight’s insights may be so valuable. For by analogy with the economic entrepreneur, we may conceive of the physician as a health entrepreneur, shouldering on behalf of the patient the inherent uncertainty associated with an illness.
Like the economic entrepreneur, doctors take into account not only quantifiable knowledge, but also locally obtained, tacit knowledge. This is a concept that we associate with F.A. Hayek, but a similar idea has been validated recently by psychologist Gary Klein in his studies on how experts—including doctors—make decisions. The totality of available knowledge is used, explicit and implicit.
And we could push the analogy of the physician as health entrepreneur further if we recognize that, in a praxeological sense, the patient gives up ownership, or cedes control, of his or her body to the doctor.
Like the economic entrepreneur, the physician is now directly invested in the outcome for that body. It is through that investment that the physician communicates his or her clinical judgment, a judgment that, as Knight would think, cannot be properly articulated.
Entrepreneurship and the healthcare system
Is this understanding of the entrepreneurial nature of medical care an academic exercise? Not if we consider the extent to which the healthcare systems runs counter to it.
For doctors are precisely asked to communicate, for the benefit of third parties, and through endless documentation and arcane coding, an exercise in judgment which is inherently unsuited for linguistic or numerical articulation.
And this demand to articulate the inarticulable is not only a distraction and a drain on the doctor’s time, but also a misleading influence on her thinking, forcing her to translate the uncertainty of medicine into a false representation that soon becomes reality: physicians, patients, and payers all get lured into mistaking the illness experience for its coded description.
We should also be mindful that third-party payers do not bear ultimate responsibility for divorcing medical care from its reality. In fact, third-party payment systems arose precisely because the medical community, in a certain sense, has made the claim that the medical enterprise could be articulated. Third-party payment systems would not have emerged if the medical community did not agree that medical care is “contractable” (a concept that finds its ultimate legal foundation in licensing laws).
Need for more research
The idea that medical care has an entrepreneurial nature may seem novel, but that is mostly because our understanding of the entrepreneur is still embryonic.
Economic science has neglected Knight’s theory of the entrepreneur for decades, focusing instead on the development of predictive models and econometric tools. Likewise, medical science has strongly favored predictive analysis, and it is no surprise, though still uncanny, that economic systems and healthcare systems share similar dysfunctions.
It is only in recent years that work by Peter Klein and others have rekindled interest in a proper understanding of the entrepreneur and of the entrepreneurial role of the business firm. I hope similar work can also shed light on a proper understanding of the doctor, the doctor-patient relationship, and the entrepreneurial work involved in the restoration of health.
That would really be a disruptive innovation.