[ExI] Avoiding bad black swan events

[Dan]

On Friday, December 14, 2012 12:56 PM Adrian Tymes <atymes at gmail.com> wrote:
> On Fri, Dec 14, 2012 at 2:05 AM, Rafal Smigrodzki <rafal.smigrodzki at gmail.com> wrote:
>> Those who think the US government will
>> help them in a Black Swan, rather than being the main cause
>> and focus of the event, are fooling themselves.
>
> That is overstating things, I think.  Look at, for instance,
> Hurricane Sandy.  The US government was not the main
> cause of the event, and it demonstrably helped many of
> those harmed by the unusual weather.
>
> (The exact level, and how much it should have done
> and/or should have been prepared, is debatable - but it
> wasn't the cause and it did help in many cases.)

The "Black Swan" event isn't really Hurricane Sandy here. Storms of this sort are rare, but anyone with long term attitude would see that they happen every several decades. A true black swan would be more like an unknown unknown, where crunching data beforehand and looking at history is unlikely to be a good guide to what might happen.

And Taleb, in his recent book, doesn't really talk so much about how to forecast such black swans. Instead, he seems, in my understanding, to think the enterprise of forecasting them is dubious and likely to make one overconfident. And he seems, again, in my understanding, to counsel making people, things, and institutions more "anti-fragile" not so much because we know the likelihood of a black swan but because we don't and fragile things are guaranteed to break given enough time. (To be sure, anti-fragile things will break too, they just usually take longer and they don't require every tiny shock to be avoided. Think of how, for instance, if you hot box a plant rather than growing it outside. Now, there might be good reasons to do this, but it's likely that any small change in the plant's environment is likely to "break" it. The outdoor plant, facing ups and downs of temperature, moisture, light, etc. is likely to not be broken by any little shock. A
 big enough shock, of course, will still do it in.)

Back to the government involvement here, it does set up a fragile system along several lines, most of which relate to perverse incentives -- incentives to take risks one wouldn't otherwise do, such as buy a home one couldn't otherwise afford or put it in a location that insurance not subsidized by the government won't cover. (Government flood insurance itself sets up a perverse incentive as the tax base ends up subsidizing people to live in areas of high flood risk. This isn't to say people consciously choose to live in these areas because the insurance is subsidized, but, at the margin, this lowering of the costs creates an incentive -- by removing or lessening a disincentive -- to make a bad choice.) Another broader fragility is the kind of debt levels encouraged by government -- through several factors, including overall inflation and taxing savings (which reduces the incentive to save overall) -- which puts people more at risk when a genuine black
 swan happens.

Of course, one could argue Sandy was a black swan from the perspective that many people simply didn't expect it: in other words, it's a black swan for them, though perhaps not for one paying a bit more attention to the hurricane record of the last century and not understanding thing like power laws. Granted. Even in this case, the fragility is in living in a location where the risk of flooding is high even if one doesn't know how often such floods might happen or what might cause them. 

And I do agree with your parenthetic comment. It's certainly much easier, after the storm, to talk about what should be done. Beforehand, perhaps the best remedy, though this would take a long time to implement, but the sooner we do the better, is to make the overall system less fragile by removing the perverse incentives across the board, especially the incentives to being in debt. (Taleb rails against debt, and here I agree with him, but you don't need his reasoning to see that being in debt puts one at high risk for a variety of things. This is also an area where individuals can just do better regardless of the overall system -- perhaps by reducing or eliminating debt and not chasing after all the goodies. A lot of this seems like playing Russian roulette with a gun with thousands of chambers -- a favorite Taleb metaphor. For quite a while, you do well and it seems like nothing's wrong, but the one chamber with the bullet can erase all that. It's easy
 to see how this happened with someone with all their wealth in a beach house in NJ, but not so easy to see how this is riddled throughout society. Again, we now know, I hope, how to deal with another Hurricane Sandy, though the black swan now would be a disaster unlike Sandy and the worry would be that we have a society too fragile to deal with it any better than with Sandy. Making ourselves "antifragile" here likely involves very unpleasant short run costs.)

Regards,

Dan
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