My aim in this blog post is to reflect on an underlying aspect of the pandemic: that is, uncertainty affecting policy makers and regulators. I am of course not the first who attempts to draw attention to uncertainty in relation to the pandemic. Horst Eidenmüller in his recent contribution on the desirability of regulatory competition also pointed to the ‘huge information deficit’ that societies were facing, and Luca Enriques also recently wrote on uncertainty in his post on pandemic resistant corporate law.

Uncertainty is a vague concept. It can have different states. Donald Rumsfeld famously captured this point when differentiating between what he called known-unknowns—‘we know there are some things we do not know’ and unknown-unknowns, which describe a state of complete ignorance: we simply don’t know what we don’t know. The important point is (following Keynes and Knight) that uncertainty is different from risk. Risk is supposed to be measurable (good enough data allows assigning probabilities to future events); uncertainty is not. Hence, uncertainty will be a problem for anyone that must take a view of the future when making decisions.

John Kay and Mervyn King recently observed that the occurrence of a global pandemic was a known-unknown. It was likely at some point, but they ask ‘what was the probability that coronavirus would break out in Wuhan in December 2019?’ They point out that there is just no sensible answer to such a question. Importantly, now that the pandemic is in full swing, uncertainty has not suddenly vanished. It is all around. It is in this environment that decision-makers must make decisions that a few months ago seemed remote or even unthinkable. Think of social distancing, decided at the highest political level. Think also of the many recent interventions of financial regulators or central banks. The fact that decision-makers operate in an environment clouded with uncertainty was driven home by the FCA in its business plan for 2020/21:

‘[t]he magnitude and duration of the economic shock resulting from coronavirus is highly uncertain. … The new features of the pandemic, and of the environment in which it occurs, lead to an untested and largely unpredictable impact on confidence and investor/consumer behaviours. This shock is not like previous economic downturns, but nor will it follow the pattern of a natural catastrophe, where the damage can be sized relatively quickly. Here, there is enormous uncertainty about the size and nature of potential damage’.

It is against this backdrop of heightened uncertainty that an academic debate on financial regulation should take place. One paradigm that is often given attention in the context of a discussion of uncertainty, especially where coupled with the prospect of irreversible losses, is the precautionary principle. Essentially, the idea is that where an activity threatens to cause irreversible damage, but there is no scientific certainty, precautionary action might be warranted. Covid-19 has started to generate interest in the precautionary principle. Some have turned to it in order to assess the actions or inactions of policymakers. Norman, Bar-Yam and Taleb for example chastise the UK’s initial herd immunity approach which they describe as ‘nothing more than a dressed-up version of the “just do nothing” approach’ and note that when faced with uncertainty, ‘both governance and precaution require us to hedge for the worst’. Meanwhile, Greenhalgh and her co-authors, writing in the British Medical Journal, turn to the precautionary principle in order to argue that policy-makers should recommend the wearing of face masks by the public in the UK. Likewise, calls to improve resilience by building redundancy in response to supply chain frailties (see Beata Javorcik (paywall)), can be understood as an application of the precautionary principle.

That said, the precautionary principle has its critics. Among them is Cass Sunstein. Sunstein has long been a supporter of quantitative cost-benefit analysis and a sceptic of the added-value of a precautionary principle. For Sunstein, a major problem with the precautionary principle is that it is ‘paralysing’: it can forbid both action and inaction since both can give rise to risks.

What has this brief discussion yielded so far? First, uncertainty is a major problem for decision-makers, including financial/banking regulators. Second, a precautionary approach might have a raison d’être in the face of (unmeasurable) uncertainty and where there is real prospect of irreversible losses. From this, I draw two conclusions. The first is about acknowledging uncertainty and the absence of ‘business-as-usual’ parameters when putting forward proposals on how to respond to the pandemic and its consequences for the economy and financial markets. At a time where much is unknown, it seems sensible that the debate should be redirected towards a more careful appraisal of the role of uncertainty when considering responses to the current crisis. Consider in this context, the contribution of Chiu, Kokkinis and Miglionico on financial regulation suspensions. They argue that decisions about suspensions should not take place outside a proper framework, but be justified ‘within the key tenets of existing institutions’. Hence, they seek, inter alia, to make the most of cost-benefit analysis notwithstanding a lack of dependable numbers. This is perceptive work. But what would have deserved a fuller discussion is the impact of uncertainty on this framework (although to be fair, problematising uncertainty would have required more space than a blog post). The second conclusion is tentative and will require more work. Recall that the need to build resilience in the financial system was a major lesson of the financial crisis. As noted, it can be expected that as the world emerges from the pandemic, one of the lessons will be that it is an imperative in other sectors too. A precautionary principle will support such thinking. However, the elephant in the room is whether the precautionary principle has something to offer to financial/banking regulators. To be sure, in the wake of the great financial crisis, some have argued that financial regulators should apply a precautionary principle. This was essentially a call for regulators to take a pro-active approach to regulation. The current crisis is different. The question that arises is whether under current conditions, a precautionary principle has something to offer when financial/banking regulators consider interventions in markets. Prima facie, there are reasons to be sceptical. One difficulty is (building on Sunstein) that it is not clear what a precautionary principle would actually yield, especially if the aim is to avoid irreversible costs. Would it support interventions (including, financial regulation suspensions, financial action, etc) or would it caution against swift actions? Both action and inaction may prima facie give rise to irreversible costs (eg to the economy or financial stability). The jury is out. But should we therefore stop the debate? Clearly not. As the corona crisis unfolds and subsides and as we seek to learn lessons for the future, there is room for a richer debate about uncertainty and in this context whether and, if so, how to operationalise a precautionary principle.

I wish to thank Prof. Iris Chiu of UCL Laws for sharing views on an earlier draft.

Pierre Schammo is a Reader (Associate Professor) in Law at Durham Law School