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Hitachi Research Institute

President Column

Commentary by our President, Hitoshi Shirai

President Column #2: Preparing for Risks

Suppose that for some reason we have only three days left to live. Given this extremely short time span, it would be totally meaningless to sacrifice the present for future possibilities or affluence. For many, the most rational act would be to pursue what they can or want to achieve in the three days, or, in other words, their “immediate desires.” This is also why the question of “what would you eat for your last meal” is always a hot topic for discussion.

What if our life ends in three months’ time? Although it still makes no sense to invest in the distant future, such as aiming for career advancement or studying hard to enter a top university, this slightly longer period of time allows us to possibly make a last trip to the countries we have not visited before due to daily and work commitments. Knowing that our “routine life” will come to an end after three months, it is only natural that we tend to seek “extraordinary” experiences.

The scenario is a little more intricate in the world depicted by the famous writer, Kotaro Isaka, in "Fool of the End Times," where an asteroid was said to hit the earth in eight years’ time. The story was set on a society five years after the announcement that humankind would be extinct. As time slipped by, those who fell into panic out of hopelessness at first had begun to lead an ordinary life in a temporary state of peace. Here, we see a reversal from an “extraordinary” to an “ordinary” state.

As opposed to what I have described above, there does not exist a situation in the real-life world where the future is almost clearly visible. We are constantly subject to the risks of an uncertain future.

Current information suggests that the probability of the Nankai Trough earthquake occurring is 60% to 70% in the next 30 years, and 90% in the next 50 years. In the worst scenario, the death toll is estimated to be 320,000, with economic losses amounting to 220 trillion yen. Despite the high likelihood of immeasurable damage, we are unable to predict if the earthquake will occur three days, three months, or 50 years later. Based on the anticipated damage, it is not difficult to picture the scale of the devastation. However, the fact that most of us continue to lead an “ordinary life” today means that we are assuming the earthquake will not hit in three days’ time. Unfortunately, it would not be possible to reduce the number of casualties to zero even if we were to take all the possible preventive measures. This has led many people to continue living their “ordinary life” instead of going after their “desires” or “extraordinary” experiences even after the prediction was announced. Meanwhile, if the forecast is correct, then the chances of it occurring tomorrow will be higher if nothing happens today.

In social psychology, the term “normalcy bias” refers to the tendency to maintain calmness by downplaying slightly unusual events to an acceptable extent. This is a function necessary to prevent overreaction and mental exhaustion caused by events that occur in our everyday lives. Indeed, we would not be able to lead a normal daily life if we keep worrying about a major earthquake which we have no clue when it will occur, even though immense damage is expected. On the contrary, an excessive degree of “normalcy bias” prevents one from making adequate preparation for risks, and slows down one’s response in taking preventive actions due to the inability to identify a dangerous situation as an abnormal event.

With economic activities becoming more globalized today, companies are facing much greater risks. While progress has been made in risk management techniques, a large number of issues remain to be addressed if we consider the predictability of risks and the possibility of managing them.

It goes without saying that a severe economic crisis has a huge impact on companies. Looking back, there were nine major economic shocks in the past three decades, including the burst of the economic bubble in Japan, the Asian economic crisis, the burst of the IT bubble, and the downfall of Lehman Brothers. With a crisis occurring almost every three years, this can no longer be deemed as an “unexpected” event in the context of business management. Unfortunately, modern quantitative approaches, including econometric ones, are still unable to play an adequate role toward enhancing the predictability of such economic crises.

In business management, there is no room to feel intimidated by risks. The only way is to face them, manage them, and move forward without slipping into the state of “normalcy bias.” According to Peter Bernstein in his work titled “Against the Gods: The Remarkable Story of Risk,” the word “risk” originates from “risicare” in Italian, which means “to challenge with courage.”