Monday, December 5, 2011

The Problem with Black Swan Events

Richard Fernandez writes about why our elites are so inept at predicting "black swan" events, drawing from this article at Foreign Affairs by Nassim Taleb and Mark Blyth (which unfortunately is behind a pay-wall).

However, the premise starts with asking the question of why didn't anyone predict the fall of the Egyptian government or the financial crises? Taleb concludes:
The critical issue in both cases is the artificial suppression of volatility -- the ups and downs of life -- in the name of stability. It is both misguided and dangerous to push unobserved risks further into the statistical tails of the probability distribution of outcomes and allow these high-impact, low-probability "tail risks" to disappear from policymakers' fields of observation. What the world is witnessing in Tunisia, Egypt, and Libya is simply what happens when highly constrained systems explode.

Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite. These artificially constrained systems become prone to "Black Swans" -- that is, they become extremely vulnerable to large-scale events that lie far from the statistical norm and were largely unpredictable to a given set of observers.

Such environments eventually experience massive blowups, catching everyone off-guard and undoing years of stability or, in some cases, ending up far worse than they were in their initial volatile state. Indeed, the longer it takes for the blowup to occur, the worse the resulting harm in both economic and political systems.
Fernandez elaborates:
...there is very little chance that anyone “serious” (like a major politician or newspaper) will take up decentralizing power as an issue, for what Taleb’s analysis implies is that the elites need to lose power. Just as the US Congress has responded to deficit crisis by appointing an even smaller “supercommitee,” the EU has similarly reacted to its woes by saying “we need more control, we need more discipline, we need a tighter union.” Yes, all we need to free ourselves from the last 5 Year Plan is another 5 Year Plan. Not.

One might even conjecture that a single, centralized narrative is in itself inimical to information. When E. E. Schattschneider said, “Democracy is not to be found in the parties but between the parties,” he was on to something. It is not that either party has the truth, but simply that a debate between any two genuinely opposed sides facilitates the emergence of the truth, even as a byproduct. This is a clue to why freedom works. It prevents the emergence of a single authoritative dogma, which left to itself would ruthlessly exterminate all other points of view, the truth in especial, if it were inconvenient.

In a sense the giant Black Swan is the dual of the giant, too-big-to-fail, too-precious-to-abandon project. They need to be dismantled. It also implies that the OODA loop needs to move down so its response time can be shortened. But that requires an admission that in a very fundamental sense the elites are not in control — that we’re riding the bronco — that the world cannot always be bent to their will. That admission can only be pried from their cold, powerless hands.

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