Will the losses occur?

RISK

UNCERTAINTY

The economic analysis of projects is conducted in an atmosphere of risk and uncertainty. Situations of risk are usually defined as those in which the potential outcomes can be described using well-known probability distributions. The example of flood risks is often used to illustrate this. If it is known that a river will flood to a specific level once every 30 years on average, a situation of risk (not uncertainty) exists.

Where uncertainty is present, potential outcomes cannot be described in objectively known probability distributions. These situations are therefore much more difficult to analyze than risks. They include many economic, political, and meteorological events, where a wide set of random influences shape events. To use extreme examples, few statisticians would feel comfortable in reliably predicting a stock-exchange collapse, patterns of civil disorder or a tornado track.

Q. What’s the difference between risk and uncertainty?

A.________________________________________ __________________________________________ __________________________________________

Most governments accept the principle that mitigation and vulnerability reduction are important components of an effective development portfolio and are most effective when incorporated into on-going development. Therefore, governments are increasingly willing to build planning systems to achieve this.

Where a more structured analytical and decision-making framework can be useful in policy-making, there is a range of methods for identifying and clarifying the complex mix of competing costs and benefits associated with any restructuring of investment priorities to accomplish disaster mitigation. These methods allow options to be compared against a standard. For most governments and international development agencies, the predominant focus for comparison will be the return on investment that an option will give.

Because the analysis of development projects is carried out in the context of uncertainty, methods for dealing with this can sometimes be quite complex. Nevertheless, a number of relatively simple and trustworthy approaches have been developed for use in practical development planning. A more detailed discussion of cost/benefit analysis is included in Annex 1.