Discovery Process as Antidote to Chaos and Volatility

The prolific author Matthew Ridley at the Wall Street Journal reviews my favorite iconoclast Nassim Nicolas Taleb’s new book Antifragile

Discovery is a trial and error process, what the French molecular biologist François Jacob called bricolage. From the textile machinery of the industrial revolution to the discovery of many pharmaceutical drugs, it was tinkering and evolutionary serendipity we have to thank, not design from first principles. Mr. Taleb systematically demolishes what he cheekily calls the "Soviet-Harvard" notion that birds fly because we lecture them how to—that is to say, that theories of how society works are necessary for society to work. Planning is inherently biased toward delay, complication and inflexibility, which is why companies falter when they get big enough to employ planners.

If trial and error is creative, then we should treat ruined entrepreneurs with the reverence that we reserve for fallen soldiers, Mr. Taleb thinks. The reason that restaurants are competitive is that they are constantly failing. A law that bailed out failing restaurants would result in disastrously dull food. The economic parallel hardly needs spelling out.

The author is a self-taught philosopher steeped in the stories and ideas of ancient Greece (a civilization founded, of course, by traders like Mr. Taleb from Lebanon, as Phoenicia is now known). Anti-intellectual books aren't often adorned by sentences like: "I have been trying to bring alive the ideas of Aenesidemus of Knossos, Antiochus of Laodicea, Menodotus of Nicomedia, Herodotus of Tarsus, and of course Sextus Empiricus." So he takes his discovery—that knowledge and progress are bottom-up phenomena—and derives an abstract theory from it: anti-fragility.

Something that is fragile, like a glass, can survive small shocks but not big ones. Something that is robust, like a rock, can survive both. But robust is only half way along the spectrum. There are things that are anti-fragile, meaning they actually improve when shocked, they feed on volatility. The restaurant sector is such a beast. So is the economy as a whole: It is precisely because of Joseph Schumpeter's "creative destruction" that it innovates, progresses and becomes resilient. The policy implications are clear: Bailouts risk making the economy more fragile.

In short, tolerance of failures, errors and the acceptance of change through risk taking, as well as, learning from and improving on them signifies as an ideal way to deal with uncertainty from which progress springs.

Nassim Taleb on AntiFragility: 5 Rules Where Society can Benefit from Volatility

At the Wall Street Journal, my favorite iconoclast Black Swan theorist and author Nassim Nicolas Taleb explains his 5 rules where society can benefit from randomness, volatility or anti-fragility

Definition of fragility and antifragility:

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.

Mr. Taleb’s five rules accompanied by excerpted elucidations (italics mine)

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…

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…

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…

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…

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…

Read the rest here

In complex systems or environments, it is a mistake to see the world as operating mechanically like a ‘textbook engineering problem’ where any presumption of knowledge applied through social policies only leads to greater volatility and risks. 

Differently said, social policies that have been averse to change or designed to eliminate change leads to unintended consequences. Economist David Friedman’s take on the mistake of adhering to the change averse "precautionary principle" rhymes with Mr. Taleb’s antifragile concepts.

Also the idea of centralization only concentrates systemic risks and volatility. Whereas decentralization not only distributes and reduces the impact of volatility but also encourages innovation and thus progress.

Bottom line: Randomness, volatility and antifragility is part of human life. Society would benefit more by learning and adapting. Decentralized institutions are more suited to deal with antifragility. Presuming away the reality of change, which has been embraced by populist politics, only defeats the 'feel good' and ‘noble’ intentions of such social policies.

Quote of the Day: Why the Precautionary Principle is a Mistake

Over my lifetime, more still over the past century, the cultural and political institutions of the U.S. have changed substantially, for reasons that have very little to do with immigration. Over the past million years, the climate of the earth has changed radically, time after time, for reasons that have nothing to do with anthropogenic CO2. A rise in sea level of a foot or two would create problems in some parts of the world, but not problems comparable to the effect of half a mile of ice over the present locations of Chicago and London. 

The conservative mistake comes with its own pseudoscientific slogan, "the precautionary principle." It is the rule that no decision should be made unless one can be confident that it will not have substantial bad effects—the lack of any good reason to believe it will have such effects is not enough.

I have long argued that the principle is internally incoherent. The decision to (for example) permit nuclear power could have substantial bad effects. The decision not to permit nuclear power could also have substantial bad effects. If one takes the precautionary principle seriously, one is obligated to neither permit nor forbid nuclear power…

I am not arguing that there is never a good reason to fear change—sometimes a change can be reasonably predicted to have bad consequences. I am arguing that much opposition to change, across a wide range of different topics and disputes, is based on the mistaken assumption that if only that particular change is prevented, the next year, the next decade, perhaps even the next century, will be more or less the same as the present.

That is very unlikely.

This profound insight is from Economic Professor David Friedman on his blog discussing why the political hand waving against change is a mistake.

Quote of the Day: Hayek’s Road to Serfdom is about Resisting Change

Hayek never argued that the slightest deviation from laissez-faire capitalism launches a society on an unstoppable march toward tyranny. Instead, he reasoned that tyranny is the inevitable result of government policies aimed at preventing market competition from ever threatening anyone’s economic prospects. As long as voters demand that government protect them from all downsides of economic change, governments can oblige them only by shutting down, one after another, all avenues for economic change. Competition; entrepreneurship; innovation; consumer sovereignty; workers’ freedom to change or to quit their jobs; even changes in demographics. Government must obliterate these and all other sources of change if no one is to be exposed to the risk of losing a job or of having her wages or benefits cut.

Obviously, in reality governments cannot produce such a petrified paradise. But in the course of trying they will create hell on earth unless people come to accept the fact that widespread material prosperity is impossible without genuine change – and that change is impossible without some people suffering economic disappointment.

That’s from Professor Don Boudreaux at the Café Hayek.

This reminds me of former astronaut and engineer Frank Borman’s popular quote

capitalism without bankruptcy is like Christianity without hell

The Tipping Point Of The Industrial Age Political Order

Politics has been shifting along with the evolution in the economy. The problem is that most people’s mindset has still been stuck with archaic models and or of visions of the previous order.

Old One Horse Shay (Wikimedia)

Walter Russell Mead captures neatly this intuitive ‘resistance to change’.

Mr. Mead writes, (bold highlights mine)

Krugman and the Times editorial board are both examples of something important in American life today: left-liberal intellectuals are increasingly able to understand that individual supports of the blue social model are crumbling. But they are still so captivated by the blue model, so profoundly convinced that the Progressive movement’s solutions to America’s social ills in 1910 are still valid today, that they cannot yet look beyond the blue model to imagine a different and brighter future for the United States....

If, as Krugman posits, demand for US workers will be falling in both manufacturing and the professions, how exactly will labor unions get higher wages for their members? Factories will be closing in Krugman’s world and law firms will be turning more and more work over to computers or shipping it overseas. Perhaps stronger unions could make it harder for companies to do this for a while, but ultimately facts speak. Stronger unions making tougher wage demands will not exactly persuade American (and foreign) investors to create new jobs in this country — or to slow down their efforts to reduce their US workforce by outsourcing and automation. When human workers receive rising wages, become harder to fire, and are governed by ever more convoluted and expensive work rules, replacing them with computers becomes more attractive, not less.

Unions tend to flourish when demand for workers is rising (as in China today); they do not and cannot protect the situation of workers as a whole against a background of falling long-term demand for their work.

The problem isn’t that this or that piece of the blue social model is breaking down and needs to be fixed so that the rest of the model can go on working well. It’s not that the university system is broken and that if we fix that the model still works. Ditto the public sector unions or the situation of the labor movement as a whole. Mandating an expensive new set of health care entitlements at a time of looming insolvency won’t help either.

The problem with the blue social model today is systemic. It’s not a problem with one piece or another. The pieces are all falling down and breaking apart at once. It is what happened to the “One Hoss Shay” in Oliver Wendell Holmes’ poem about, they used to teach us back in Pundit High, the breakdown of Calvinist religion in New England.

Read the rest here.

Like the transition of the economic order from agriculture to industry, we are seeing also the same transition from industrial era to the information age. And since the economy drives politics, so will the political structures shift accordingly.

The important point is that these ‘political-economic’ transitions represent a discovery process. It will NOT happen overnight. It will come with painful episodes of trial and errors with many fine tuning along the way.

It will also come with the auto response mechanism known as “resistance to change” especially from entrenched parties that had long benefited from the old order. Walter Mead’s take down of left-liberal intellectuals go along this line of thought.

Labor unions can be compared to current government budget deficits modelled after Bismark’s welfare states. All have been based on the industrial age top-down concept.

And the same top-bottom dynamic goes along with information flows as seen through the previous mainstream media model. But the web has been providing intense competition such that the old force appears to be breaking down. And unlike governments and their apologists, who seem plagued by intellectual stasis, many in the media appear as trying to cope with the changes of the current trends.

While the welfare construct could be seen to have worked earlier, these economically unsustainable platforms have been giving way. In short, the politics of the industrial age may have reached its tipping point.

And as the revolutions in Greece or the MENA, or the standoff in Wisconsin manifests, they operate on a common denominator—the political economic structure of the industrial age has been crumbling.

Many will struggle to maintain the old order, and that’s why transitions are never smooth. But at the end of the day, we are likely to learn how to adjust to these new realities in spite of the conflicts. Alternatively, this extrapolates to "don't fight the trend".

And I close with Mr. Mead’s conclusion...

This is the essence of progress: as we move forward less of our society’s time and energy goes into just staying alive; more of it goes into living better. The key to that now is to move as quickly as possible to reshape these critical professions with the full power of information technology

Amen.