The Stone City

Words Made to Last

Wednesday, August 24, 2005

Risk Neutrality

The Iranian claim that its nuclear program is intended solely for peaceful purposes tends to run into skepticism, due to the conventional wisdom that an oil-exporting nation has no real need for nuclear power. Matt Yglesias imagines that he has debunked this idea:
How much oil a country has is totally unrelated to the desirability of establishing non-oil energy sources, including nuclear plants.
... A country like Iran, especially, where oil is both plentful and owned by the state, can just get oil for free. Superficially, that's a very different situation. Fundamentally, however, the situations are identical.
The reason is that Iran can export a quantity of oil that equals total Iranian production minus domestic consumption. Reducing domestic consumption increases export earnings which increases the amount of non-oil goods you can buy.
Mr. Yglesias is implicitly assuming that nations, and the people inhabiting and ruling them, are risk-neutral and seek only to maximize their expected gain. And under this assumption, his analysis would indeed be correct.

But nations, like people, tend to be risk-averse. For good reason: extra risk means extra economic uncertainty, which leads to more conservative and less accurate asset allocation, decreasing wealth in the medium term. A nation like Japan decreases its economic risk by investing in nuclear power; a nation like Iran increases it. Thus the conventional wisdom, however boring, is right.

[Update: JW Mason makes the same point in Mr. Yglesias's comments, and is attacked by people who cannot distinguish between reducing risk and eliminating it.]