Black Swans and Unintended Consequences

By Pat Murphy

Reading Nassim Taleb is a reminder of the pervasively unforgiving nature of the law of unintended consequences. On a long plane trip last summer, I took a crack at Nassim Taleb’s The Black Swan, the 2007 book in which he predicted the financial crash. Whether because of the rigours of air travel or the nature of the material, it was a hard slog.

The basic message was clear: black swans, which are defined as unpredicted and consequential events, can upend the best laid plans. But other than that, it was difficult to find a concise takeaway.

Taleb is a former derivatives trader who made a pile of money by betting against the conventional wisdom. And he is now back with a new book – Antifragile: Things That Gain From Disorder. Fortunately, he has also written an accessible Wall Street Journal article that provides a guide to some of the book’s main ideas.

In Taleb’s telling, fragility refers to “things that are vulnerable to volatility” whereas antifragility implies being able to “gain from volatility, variability, stress and disorder.” You don’t have to be a rocket scientist to figure out which quality is preferable.

He also posits a number of “policy rules that can help us to establish antifragility as a principle of our socioeconomic life.” While not particularly novel or earth-shattering, several of these are worthwhile insights that offer practical value.

One rule addresses the way in which public policy over-manages by trying to fix everything. For instance, there was the attempt to eliminate the business cycle by “injecting cheap money into the system, which eventually led to monstrous hidden leverage and real-estate bubbles.” By interfering with the system’s ability to self-correct, problems were masked until they became much bigger. And the resulting mess was far more destructive.

Taleb makes it clear that he’s not opposed to all government intervention. Rather it’s a matter of recognizing that in highly complex systems, such as modern economies, effective intervention is difficult. So you should really pick your spots.

Another rule riffs on the small is beautiful theme, making the point that small can also be more efficient. To be sure, economies of scale can be real and size can be a decided asset. But size also increases complexity, fragility, and the exposure to large losses. For anyone who’s ever been involved in project management, this won’t come as a surprise.

Then there’s the matter of how trial and error can be superior to academic knowledge – subject to the caveat that the cost of error is small and the potential for gain is large. As evidence, Taleb notes that Britain’s Industrial Revolution was driven by tinkerers rather than academic researchers (a point also made at some length by Terence Kealey in 2008’s Sex, Science and Profits).

And Taleb is big on the need for decision makers having “skin in the game.” As he puts it, “At no time in the history of humankind have more positions of power been assigned to people who don’t take personal risks.”

But while he’s certainly right about both this observation and its capacity to cause problems, practical remedies will be hard to come by for anything but the most egregious situations. After all, the last 50 or so years have produced an enormous professional class, duly credentialed and distributed through public and private bureaucracies. Making decisions about other people’s money and lives is what they do.

Reading Taleb is a reminder of the pervasively unforgiving nature of the law of unintended consequences. Actions that are supposed to promote good things can often come with an unanticipated sting in the tail. And sometimes that sting is downright poisonous.

Alan Greenspan had the best of intentions when he pumped liquidity into the financial system. As Taleb puts it, he was trying to “smooth” things out, not create a speculative boom.

Current low interest rates are meant to stimulate economic activity. But in the process, they make life difficult for pension funds and retired people living on their savings.

As for the lack of “skin in the game,” the separation of ownership and management was once considered a progressive development, the idea being that it brought together ability and power. Decisions would now be made by those best qualified, not by those who had simply inherited businesses from their fathers.

Life is indeed complicated.

Troy Media columnist Pat Murphy worked in the Canadian financial services industry for over 30 years. Originally from Ireland, he has a degree in history and economics.

Article provided by Troy Media, http://www.troymedia.com

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