Friday, April 19, 2013

236. Antifragile: Things That Gain from Disorder by Nassim Nicholas Taleb

Nassim Nicholas Taleb in Black Swan - the Impact of the Highly Improbable, the second book in the trilogy referred to as Incerto, discusses rare and consequential events, which, because they occur at the tails are almost always ignored and easily explained away after they have occurred. The experts, in the fullest exhibition of their epistemic arrogance, predict that such events are one-time events and would never occur again and so are always fooled by the randomness of their occurrence. These events, in the 4th quadrant, are extremistan events. In Antifragility - Things That Gain from Randomness (Random House, 2012; 519), Nassim explains how we can benefit from these rare and consequential events by decreasing our downside to it or by employing the technique of skin-in-the-game. The book shows how we can avoid becoming the turkey which was surprised on the 1000th day after having been fed consistently for 999 days. 

According to Nassim, Black Swan events are needed to make a system antifragile by weeding out weaker units of the whole. He operates on the philosophy that what kills me makes others stronger and describes any system that gains from variability, randomness, uncertainty as antifragile; that is, anything that has more upside than downside from random events. He describes how economic systems can imitate nature in its treatment of life by learning from random events where harm to a sub-unit makes the unit stronger; for instance, the sinking of Titanic saved more lives by preventing the building of larger and larger ocean liners; also, every plane that crashes makes the next plane crash less probable. When the unit is harmed and dies its death (through the transfer of information to the others in the group) makes the group stronger and relatively antifragile.

He explains that smoothing annual business cycles hide errors which in the future causes Black Swans (events with consequential or devastating effects such as the Great Depression, Black Death, the Irish Great Famine, to the entire system). For instance, Nassim believes that the banking sector should not be different from the restaurant business. Banks should be allowed to fail and in failing will provide the necessary information (such as remaining smaller and avoiding the inefficient mergers and takeovers they embark upon) for the other banks in the sector to survive, just like restaurants. However, government interventionist programmes such as the Bank Bailouts hides and piles the errors which explode upon the least appearance of a random line of weakness, leading to an uncontrollable chain reactions where the entire sector collapses. Usually, the sum of the impact of all the individual crashes or collapses, which are mediocristan events (or common occurrences with little impact) occurring before a jump or depression is always less than the consequences (or impact) of an extremistan event after a long period of suppression. 
The longer one goes without a market trauma, the worse the damage when commotion occurs. [101]
In Ghana, the government's intervention in petroleum pricing by providing subsidies and by not allowing the automatic price adjustment formula to work produced consequential events where the budget deficit expanded and power-generation became erratic to the extent that the monolithic power-generating company had to embark on load-shedding (schedule outages to conserve power or power rationing) because the government could not meet its financial obligation on time for the purchase of crude for the Thermal Plants to produce electricity. This affected, especially, small businesses who were most often without power and in turn affected government's revenue generation. Besides, the removal of the subsidies also had a spiral inflationary consequences through a the price-transmission mechanism and had significant effects on people than would have been had the price increases been gradual and in small amounts. Thus, smoothing mediocristan variability will lead to extremistan jumps. According to Nassim, Post 9-11 US political strategy in the Middle East has been geared towards suppressing political fluctuations, which has instead increased and strengthened the Islamists by going underground. Also, countries like Egypt after Mubarak and Iraq after Saddam are examples of an extremistan events following suppression of variability. Besides, recent economic collapse of countries like Greece and Cyprus should make us rethink of how countries and businesses are currently run. Similarly, the effect of a single power failure, in a place where power failures are very rare, could affect so many things such as hunger (in people's homes), traffic accidents, deaths in hospital, than in countries where power failure is a common occurrence. Nassim refers to the situation where benefits from interventions are less than the harm that results as Iatrogenics.

Funny enough, when these economic collapses occur, after the intervention, those who prescribed the cure that led to the doom, those whom Nassim refers to as Fragilistas and who confuse what they do not know with its non-existence (the absence of evidence with evidence of absence), in the full glow of their epistemic arrogance are those who offer, or are called upon to offer, solutions. In spite of the fact that they proffer further complicated interventions they do not understand, they also do not have their skin in the game and so suffer no consequences of their actions. If they are banksters, society will take the negative fallouts; if they are politicians, they will move into other lucrative positions.

However, this is not to say that by allowing mediocristan variability or randomness you automatically eliminate Black Swans. Rather, consistent exposure to mediocristan variability builds antifragility within a system. A shock to a system or body prepares the body to expect and tolerate another shock bigger than previous: information transmission from the genes to the tissues to the organs to the organism to the community.

Nassim provided some actions that predisposes economic systems to negative Black Swans; he also discussed the means to reducing the downside of fragile systems to them. Globalisation, mergers and takeovers leading to the creation of humongous companies, centralisation of governance, create fragile, black swan-prone systems. Globalisation creates massive interconnectivities and interdependence; these hide massive errors and cause greater harm in the end. An error at one node is transmitted through the system leading to devastating consequences. This is due to the non-linear responses to time and cost. For instance, the least delay in the delivery of materials could exponentially increase the cost of bigger construction projects. An over-optiminsed system is prone to negative Black Swan. In summary, growth in sophistication and complexity increases the vulnerability to collapse (downside).

He proposes that countries should be decentralised and powers devolved. At a municipal level (or counties) volatility is high, all arguments are brought to the surface and dealt with. Thus, a nation made up of a collection of such independent municipals with their own localised volatility form a stable country. However, for a centralised governance system, troubles are impersonal and remain hidden, creating inefficiency, and if suppressed, lead to collapse. Similarly, countries with tumultuous politics are generally more stable than those top-down governments that pile concrete on their lines of weakness; in the latter, the first explosion is usually very devastating leading to uncontrollable chain reaction.

According to Nassim it is easier to predict if events or things are fragile or antifragile than to predict what events will harm them. In extremistan one is likely to be fooled by the stream of past events since Time Series data cannot be used to predict the occurrence of a black swan. He believes that any company which is liable to bail-out should be nationalised and the people be paid like any other civil servants. He calls for the Balkanisation of Banks, breaking their interconnectedness, to allow each to work or stand on its own and be responsible for its actions. Operating as independent units, the variability (randomness) is distributed across the units leading to frequent rise and falls and in situations where a Black Swan occurs leading to the death of one or two with information  sent to the others to make them stronger.

Finally, Nassim calls for the skin-in-the-game approach to solving the increasing trend where some individuals, especially those he refers to as Banksters, are antifragile because they get the upside from positive Black Swans and society gets the downside from negative Black Swans. This system, he argues, is flawed. He who gets the upside must bear the downside. Why should profits be privatised and losses, socialised? He sees it as fraud. Our ability to forecast or predict events especially Black Swan events is zilch; people should therefore desist from it. Else those who dabble in it should be made to bear the consequences of their predictions - they should necessarily have their skin in the game for the game to be fair. Skin-in-the-game addresses invisible and delayed iatrogenics and ensures that those who have the upside get the downside. It is similar to the Akan proverb that if the Chief does not go to war, the servant stays behind; if you are a chief and you want war, take lead and the servant will follow (get the upside of victory and the downside of death). A decision-maker must be made to bear the consequences of his decisions.

The book is divided into seven parts or books. It contains both very literary works and very technical (or even mathematical) explanations. One reviewer of Nassim's Black Swan complained of how easy and simple the write is and that it could be understood by anybody; however, instead of giving the author a plus, the reviewer thought it as bad and a symptom of frivolity. From that reviewer, books are meant to be difficult; she confused complexity with quality. And it is people like this that Fat Tony will say 'F*** off' to. Those filled with a certain sense all-knowingness. The author himself directs the non-technical reader to skip certain chapters because they are mere technical repetition of what had literally being explained. He also provides very technical notes at the appendix. If nothing at all, Nassim's chapter and section headings will draw the reader into reading. They are unique and catchy. This is a book that will make you think, think, and think again. For those of us who dabble in econometric modelling and talk a lot about forecasting economic events with the models we have and talk about Confidence Interval and others, if only you are not stubbornly entrenched, you will think about what you do. The author draws extensive examples and analogies from various fields. He talks about Seneca, his favourite philosopher, he talks about Mithridates, Socrates. And there are Nassim's fictional characters Fat Tony and Dr John. This is a book worth reading. The principles in there, if practiced, will change the world.

2 comments:

  1. I ve yet to read black swan which has been on my shelves for a few years ,all the best stu

    ReplyDelete
    Replies
    1. Do read it. Personally, I've professional interest in his books.

      Delete

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