By Nassim Nicholas Taleb
Several years before the financial crisis
descended on us, I put forward the concept of “black swans”: large events that
are both unexpected and highly consequential. We never see black swans coming,
but when they do arrive, they profoundly shape our world: Think of World War I,
9/11, the Internet, the rise of Google .
In economic life and history more generally,
just about everything of consequence comes from black swans; ordinary events
have paltry effects in the long term. Still, through some mental bias, people
think in hindsight that they “sort of” considered the possibility of such
events; this gives them confidence in continuing to formulate predictions. But
our tools for forecasting and risk measurement cannot begin to capture black
swans. Indeed, our faith in these tools make it more likely that we will
continue to take dangerous, uninformed risks.
Some made the mistake of thinking that I
hoped to see us develop better methods for predicting black swans. Others asked
if we should just give up and throw our hands in the air: If we could not
measure the risks of potential blowups, what were we to do? The answer is
simple: We should try to create institutions that won’t fall apart when we
encounter black swans—or that might even gain from these unexpected events.
Fragility is the quality of things that
are vulnerable to volatility. Take the coffee cup on your desk: It wants peace
and quiet because it incurs more harm than benefit from random events. The
opposite of fragile, therefore, isn’t robust or sturdy or resilient—things with
these qualities are simply difficult to break.
To deal with black swans, we instead need
things that gain from volatility, variability, stress and disorder. My
(admittedly inelegant) term for this crucial quality is “antifragile.” The only
existing expression remotely close to the concept of antifragility is what we
derivatives traders call “long gamma,” to describe financial packages that
benefit from market volatility. Crucially, both fragility and antifragility are
measurable.
As a practical matter, emphasizing
antifragility means that our private and public sectors should be able to
thrive and improve in the face of disorder. By grasping the mechanisms of
antifragility, we can make better decisions without the illusion of being able
to predict the next big thing. We can navigate situations in which the unknown
predominates and our understanding is limited.
Herewith are five policy rules that can
help us to establish antifragility as a principle of our socioeconomic life.
Rule 1: Think of the economy as being more
like a cat than a washing machine.
We are victims of the post-Enlightenment
view that the world functions like a sophisticated machine, to be understood
like a textbook engineering problem and run by wonks. In other words, like a
home appliance, not like the human body. If this were so, our institutions would
have no self-healing properties and would need someone to run and micromanage
them, to protect their safety, because they cannot survive on their own.
By contrast, natural or organic systems
are antifragile: They need some dose of disorder in order to develop. Deprive
your bones of stress and they become brittle. This denial of the antifragility
of living or complex systems is the costliest mistake that we have made in
modern times. Stifling natural fluctuations masks real problems, causing the
explosions to be both delayed and more intense when they do take place. As with
the flammable material accumulating on the forest floor in the absence of
forest fires, problems hide in the absence of stressors, and the resulting
cumulative harm can take on tragic proportions.
And yet our economic policy makers have
often aimed for maximum stability, even for eradicating the business cycle. “No
more boom and bust,” as voiced by the U.K. Labor leader Gordon Brown, was the
policy pursued by Alan Greenspan in order to “smooth” things out, thus
micromanaging us into the current chaos. Mr. Greenspan kept trying to iron out
economic fluctuations by injecting cheap money into the system, which
eventually led to monstrous hidden leverage and real-estate bubbles. On this front
there is now at least a glimmer of hope, in the U.K. rather than the U.S.,
alas: Mervyn King, governor of the Bank of England, has advocated the idea that
central banks should intervene only when an economy is truly sick and should
otherwise defer action.
Promoting antifragility doesn’t mean that
government institutions should avoid intervention altogether. In fact, a key
problem with overzealous intervention is that, by depleting resources, it often
results in a failure to intervene in more urgent situations, like natural
disasters. So in complex systems, we should limit government (and other)
interventions to important matters: The state should be there for
emergency-room surgery, not nanny-style maintenance and overmedication of the
patient—and it should get better at the former.
In social policy, when we provide a safety
net, it should be designed to help people take more entrepreneurial risks, not
to turn them into dependents. This doesn’t mean that we should be callous to
the underprivileged. In the long run, bailing out people is less harmful to the
system than bailing out firms; we should have policies now that minimize the
possibility of being forced to bail out firms in the future, with the moral
hazard this entails.
Rule 2: Favor businesses that benefit from
their own mistakes, not those whose mistakes percolate into the system.
Some businesses and political systems
respond to stress better than others. The airline industry is set up in such a
way as to make travel safer after every plane crash. A tragedy leads to the
thorough examination and elimination of the cause of the problem. The same
thing happens in the restaurant industry, where the quality of your next meal
depends on the failure rate in the business—what kills some makes others
stronger. Without the high failure rate in the restaurant business, you would
be eating Soviet-style cafeteria food for your next meal out.
These industries are antifragile: The
collective enterprise benefits from the fragility of the individual components,
so nothing fails in vain. These businesses have properties similar to evolution
in the natural world, with a well-functioning mechanism to benefit from
evolutionary pressures, one error at a time.
By contrast, every bank failure weakens
the financial system, which in its current form is irremediably fragile: Errors
end up becoming large and threatening. A reformed financial system would
eliminate this domino effect, allowing no systemic risk from individual
failures. A good starting point would be reducing the amount of debt and
leverage in the economy and turning to equity financing. A firm with highly
leveraged debt has no room for error; it has to be extremely good at predicting
future revenues (and black swans). And when one leveraged firm fails to meet
its obligations, other borrowers who need to renew their loans suffer as the
chastened lenders lose their appetite to extend credit. So debt tends to make
failures spread through the system.
A firm with equity financing can survive
drops in income, however. Consider the abrupt deflation of the technology
bubble during 2000. Because technology firms were relying on equity rather than
debt, their failures didn’t ripple out into the wider economy. Indeed, their
failures helped to strengthen the technology sector.
Rule 3: Small is beautiful, but it is also
efficient.
Experts in business and government are
always talking about economies of scale. They say that increasing the size of
projects and institutions brings costs savings. But the “efficient,” when too
large, isn’t so efficient. Size produces visible benefits but also hidden
risks; it increases exposure to the probability of large losses. Projects of
$100 million seem rational, but they tend to have much higher percentage
overruns than projects of, say, $10 million. Great size in itself, when it
exceeds a certain threshold, produces fragility and can eradicate all the gains
from economies of scale. To see how large things can be fragile, consider the
difference between an elephant and a mouse: The former breaks a leg at the
slightest fall, while the latter is unharmed by a drop several multiples of its
height. This explains why we have so many more mice than elephants.
So we need to distribute decisions and
projects across as many units as possible, which reinforces the system by
spreading errors across a wider range of sources. In fact, I have argued that
government decentralization would help to lower public deficits. A large part
of these deficits comes from underestimating the costs of projects, and such
underestimates are more severe in large, top-down governments. Compare the
success of the bottom-up mechanism of canton-based decision making in
Switzerland to the failures of authoritarian regimes in Soviet Russia and
Baathist Iraq and Syria.
Rule 4: Trial and error beats academic
knowledge.
Things that are antifragile love
randomness and uncertainty, which also means—crucially—that they can learn from
errors. Tinkering by trial and error has traditionally played a larger role
than directed science in Western invention and innovation. Indeed, advances in
theoretical science have most often emerged from technological development,
which is closely tied to entrepreneurship. Just think of the number of famous
college dropouts in the computer industry.
But I don’t mean just any version of trial
and error. There is a crucial requirement to achieve antifragility: The
potential cost of errors needs to remain small; the potential gain should be
large. It is the asymmetry between upside and downside that allows antifragile
tinkering to benefit from disorder and uncertainty.
Perhaps because of the success of the
Manhattan Project and the space program, we greatly overestimate the influence
and importance of researchers and academics in technological advancement. These
people write books and papers; tinkerers and engineers don’t, and are thus less
visible. Consider Britain, whose historic rise during the Industrial Revolution
came from tinkerers who gave us innovations like iron making, the steam engine
and textile manufacturing. The great names of the golden years of English
science were hobbyists, not academics: Charles Darwin, Henry Cavendish, William
Parsons, the Rev. Thomas Bayes. Britain saw its decline when it switched to the
model of bureaucracy-driven science.
America has emulated this earlier model,
in the invention of everything from cybernetics to the pricing formulas for
derivatives. They were developed by practitioners in trial-and-error mode,
drawing continuous feedback from reality. To promote antifragility, we must
recognize that there is an inverse relationship between the amount of formal
education that a culture supports and its volume of trial-and-error by
tinkering. Innovation doesn’t require theoretical instruction, what I like to
compare to “lecturing birds on how to fly.”
Rule 5: Decision makers must have skin in
the game.
At no time in the history of humankind
have more positions of power been assigned to people who don’t take personal
risks. But the idea of incentive in capitalism demands some comparable form of
disincentive. In the business world, the solution is simple: Bonuses that go to
managers whose firms subsequently fail should be clawed back, and there should
be additional financial penalties for those who hide risks under the rug. This
has an excellent precedent in the practices of the ancients. The Romans forced
engineers to sleep under a bridge once it was completed.
Because our current system is so complex,
it lacks elementary clarity: No regulator will know more about the hidden risks
of an enterprise than the engineer who can hide exposures to rare events and be
unharmed by their consequences. This rule would have saved us from the banking
crisis, when bankers who loaded their balance sheets with exposures to small
probability events collected bonuses during the quiet years and then
transferred the harm to the taxpayer, keeping their own compensation.
In these five rules, I have sketched out
only a few of the more obvious policy conclusions that we might draw from a
proper appreciation of antifragility. But the significance of antifragility
runs deeper. It is not just a useful heuristic for socioeconomic matters but a
crucial property of life in general. Things that are antifragile only grow and
improve under adversity. This dynamic can be seen not just in economic life but
in the evolution of all things, from cuisine, urbanization and legal systems to
our own existence as a species on this planet.
We all know that the stressors of exercise
are necessary for good health, but people don’t translate this insight into
other domains of physical and mental well-being. We also benefit, it turns out,
from occasional and intermittent hunger, short-term protein deprivation,
physical discomfort and exposure to extreme cold or heat. Newspapers discuss
post-traumatic stress disorder, but nobody seems to account for post-traumatic
growth. Walking on smooth surfaces with “comfortable” shoes injures our feet
and back musculature: We need variations in terrain.
Modernity has been obsessed with comfort
and cosmetic stability, but by making ourselves too comfortable and eliminating
all volatility from our lives, we do to our bodies and souls what Mr. Greenspan
did to the U.S. economy: We make them fragile. We must instead learn to gain
from disorder.
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