Uncertainty and risk: what’s the difference?

When I last did my shopping, there weren’t any tomatoes or cucumbers on the shelves.  Good news for my salad averse son but not so great for his guinea pigs.  According to the news, the shortage is due to a combination of bad weather in countries from which we import fresh produce and high electricity prices for domestic growers that utilise greenhouses. 

The British Retail Consortium (BRC) has said that the shortages should only last a few weeks.*  However, this is just the latest issue that has contributed to a period of economic uncertainty that started with Brexit and has incorporated the coronavirus pandemic, the war in Ukraine and the cost of living crisis.

But what is economic uncertainty?

Simply put, it is when analysts can’t predict what will happen to an economy in the future.  Economic uncertainty can be caused by any number of incidents.  For example, the lead ups to general elections are periods of uncertainty because the results can change a country’s economic policies.  Although, as they usually occur every five years, they cause less uncertainty than something like Brexit, which was an irregular occurrence and so caused high levels of prolonged uncertainty.**

The bad weather currently affecting food production is an example of the increasing uncertainty caused by climate change.  Equally, unpredictable events, such as the pandemic, have far-reaching consequences for organisations.  The pandemic caused a massive downturn in the global economy because countries across the world responded by closing their economies, as scientists did not fully understand the virus initially. 

Market forces can cause uncertainty as well.  The cost of living crisis has seen prices soar, altering our spending patterns as concerns over how long it will last mean that we’re warier of parting with our disposable income unless it is absolutely necessary.  Technology can play a part too.  The start of the pandemic saw many of us working from home and unsure of how that would go, and we still don’t know what new technologies might appear in the future.

What impact does economic uncertainty have?

More often than not, economic uncertainty is associated with negative outcomes.  The pandemic saw lots of businesses struggling, and people became worried about their job security.  Uncertainty over levels of income can stop people from spending, which results in decreased demand for goods and services, followed by a reduction in the levels of supply and, ultimately, the size of the economy shrinking.  As a general rule, governments try to create an environment in which the economy can grow slowly but steadily.  This is because decreases in economic growth have knock-on effects, such as rising unemployment levels, due to organisations cutting back on their activities and staffing levels.

Economic uncertainty can also cause:

• Higher and more turbulent inflation
• Price increases
• Rising interest rates, which means that borrowing is more expensive
• Money markets are becoming less willing to finance government debt, leading to cuts in public spending
• Devaluation of currencies due to changes in exchange rates

How is uncertainty different from risk?

The difference between risk and uncertainty is whether the outcomes, or the possibility of them occurring, are known to the decision-maker or not.  When an outcome is known, it is a risk that can be managed.  For example, supermarkets currently risk running out of fruit and vegetables, so some have limited the amount of the scarce goods customers can buy.  But, how customers will react to these sales caps, is uncertain.

Being in business brings with it innate uncertainty and risks.  Business owners therefore, have to constantly balance them against the potential to make profit.  Business risk can be defined as anything that has the potential to lower an organisation’s profits or make it bankrupt.

Internal and external sources of business risk

Business risks can come from a wide variety of sources.  Internal risks are often to do with the people in an organisation, who are inherently at risk of making human errors.  So, this is usually managed by having processes and procedures in place to ensure systems work efficiently and that products and services are to an acceptable standard.  It is also sometimes mitigated by the use of technology, for example, using automation to save time by improving accuracy and efficiency.  Organisations have to balance the amount they spend to mitigate risks against the effect of that spending on profit.

External risks can be harder to manage as they reflect uncertainty about external influences on organisations.  Business owners have to make decisions in light of changes in the economy to deal with the consequences of, for example, price increases and fluctuations in interest and exchange rates.  They have to manage political risks, responding to normal changes in legislation and regulations made by governments but also the disruption caused by political unrest and war. Furthermore, organisations are at risk of unpredictable events, such as an outbreak of disease or weather-related instances like droughts, flooding or earthquakes.

Summary

The difference between uncertainty and risk can be understood in terms of tangibility.  When we don’t know the outcome of something, we have uncertainty.  However, when we can substantiate what will happen, then the risk becomes more tangible, and we can make decisions about what to do.

Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.