Beware those Black Swans

The bestselling economist Nassim Nicholas Taleb argues that we can’t make the world financial system

After completing my book The Black Swan, I spent some time meditating on the fragility of systems with the illusion of stability. This convinced me that the banking system was the mother of all accidents waiting to happen. I explained in the book that the best teachers of wisdom are the eldest, because they may have picked up invisible tricks that are absent from our epistemic routines and which help them survive in a world more complex than the one we think we understand. So being old implies a higher degree of resistance to "Black Swans" (events with the following three attributes: they lie outside the realm of regular expectations; they carry an extreme impact; and human nature makes us concoct explanations for their occurrence after the fact).

Take Mother Nature, which is clearly a complex system, with webs of interdependence, non-linearities and a robust ecology (otherwise it would have blown up a long time ago). It is a very old person with an impeccable memory. Mother Nature does not develop Alz­heimer's - and there is evidence that even humans would not easily lose brain functions with age if they took long walks, avoided sugar, bread, white rice and stock-market investments, and refrained from taking economics classes or reading the New York Times.

Let me summarise my ideas of how Mother Nature deals with the Black Swan. First, she likes redundancies. Look at the human body. We have two eyes, two lungs, two kidneys, even two brains (with the possible exception of company executives) - and each has more capacity than is needed ordinarily. So redundan­cy equals insurance, and the apparent inefficiencies are associated with the costs of maintain­ing these spare parts and the energy needed to keep them around in spite of their idleness.

The exact opposite of redundancy is naive optimisation. The reason I tell people to avoid attending an (orthodox) economics class and argue that economics will fail us is the following: economics is largely based on notions of naive optimisation, mathematised (poorly) by Paul Samuelson - and these mathematics have contributed massively to the construction of an error-prone society. An economist would find it inefficient to carry two lungs and two kidneys - consider the costs involved in transporting these heavy items across the savannah. Such optimisation would, eventually, kill you, after the first accident, the first "outlier". Also, consider that if we gave Mother Nature to economists, it would dispense with individual kidneys - since we do not need them all the time, it would be more "efficient" if we sold ours and used a central kidney on a time-share basis. You could also lend your eyes at night, since you do not need them to dream.

Almost every major idea in conventional economics fails under the modification of some assumption, or what is called "perturbation", where you change one parameter or take a parameter henceforth assumed to be fixed and stable by the theory, and make it random. Take the notion of comparative advantage, supposedly discovered by David Ricardo, and which has oiled the wheels of globalisation. The idea is that countries should focus on "what they do best". So one country should specialise in wine, another in clothes, even though one of them might be better at both. But consider what would happen to the country if the price of wine fluctuated. A simple perturbation around this assumption leads one to reach the opposite conclusion to Ricardo. Mother Nature does not like overspecialisation, as it limits evolution and weakens the animals.

This explains why I found the current ideas on globalisation (such as those promoted by the journalist Thomas Friedman) too naive, and too dangerous for society - unless one takes into account the side effects. Globalisation might give the appearance of efficiency, but the operating leverage and the degrees of interaction between parts will cause small cracks in one spot to percolate through the entire system.

The debt taboo

The same idea applies to debt: it makes you very fragile under perturbations. We currently learn in business schools to engage in borrowing, against all historical traditions (all Mediterranean cultures developed over time a dogma against debt). "Felix qui nihil debet", goes the Roman proverb: "Happy is he who owes nothing." Grandmothers who survived the Great Depression would have advised doing the exact opposite of getting into debt: have several years of income in cash before any personal risk-taking. Had the banks done the same, and kept high cash reserves while taking more aggressive risks with a smaller portion of their port­folios, there would have been no crisis.

Documents dating back to the Babylonians show the ills of debt, and Near Eastern religions banned it. This tells me that one of the purposes of religious traditions has been to enforce prohibitions to protect people against their own epistemic arrogance. Why? Debt implies a strong statement about the future, and a high degree of reliance on forecasts. If you borrow $100 and invest in a project, you still owe $100 even if you fail in the project (but you do a lot better in case you succeed). So debt is dangerous if you are overconfident about the future and are Black Swan-blind - which we all tend to be. And forecasting is harmful since people (especially governments) borrow in response to a forecast (or use the forecast as a cognitive excuse to borrow). My "Scandal of Prediction" (bogus predictions that seem to be there to satisfy psychological needs) is compounded by the "Scandal of Debt": borrowing makes you more vulnerable to forecast error.

Just as Mother Nature likes redundancies, so she abhors anything that is too big. The largest land animal is the elephant, and there is a reason for that. If I went on a rampage and shot an elephant, I might be put in jail and get yelled at by my mother, but I would hardly disturb the ecology of Mother Nature. On the other hand, my point about banks in my book - that if you shot a large bank, I would "shiver at the consequences" and that "if one falls, they all fall" - was subsequently illustrated by events: one bank failure, Lehman Brothers, in September 2008, brought down the entire edifice.

The crisis of 2008 provides an illustration of the need for robustness. Over the past 2,500 years of recorded ideas, only fools and Platonists have believed in engineered utopias. We shouldn't think that we can correct mistakes and eliminate randomness from social and economic life. The challenge, rather, is to ensure that human mistakes and miscalculations remain confined, and to avoid them spreading through the system - just the way Mother Nature does it. Reducing randomness increases exposure to Black Swans.

My dream is to have a true "epistemocracy"; that is, a society robust against expert errors, forecasting errors and hubris, one that can be resistant to the incompetence of politicians, regulators, economists, central bankers, bank­ers, policy wonks and epidemiologists.Here are ten principles for a Black Swan-robust society.

What is fragile should break early while it's still small: Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks become the biggest.

No socialisation of losses and privatisation of gains: Whatever may need to be bailed out should be nationalised; whatever does not need a bailout should be free, small and risk-bearing. We got ourselves into the worst of capitalism and socialism. In France, in the 1980s, the Socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

People who drove a school bus blindfolded (and crashed it) should never be given a new bus: The economics establishment lost its legitimacy with the failure of the system in 2008. Find the smart people whose hands are clean to get us out of this mess.

Don't let someone making an "incentive" bonus manage a nuclear plant - or your financial risks: Odds are he would cut every corner on safety to show "profits" from these savings while claiming to be "conservative". Bonuses don't accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives.

Time to definancialise

Compensate complexity with simplicity: Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. Complex systems survive thanks to slack and redundancy, not debt and optimisation.

Do not give children sticks of dynamite, even if they come with a warning label: Complex financial products need to be banned because nobody understands them, and few are rational enough to know it. We need to protect citizens from themselves, from bankers selling them "hedging" products, and from gullible regulators who listen to economic theorists.

Only Ponzi schemes should depend on confidence: Governments should never need to "restore confidence". Cascading rumours are a product of complex systems. Governments cannot stop the rumours. We just need to be able to shrug off rumours, to be robust to them. Do not give an addict more drugs if he has withdrawal pains: Using leverage to cure the problems of too much leverage is not homoeopathy, it's denial. The debt crisis is not a temporary problem, it's a structural one. We need rehab.

Citizens should not depend on financial assets as a repository of value and rely on fallible "expert" advice for their retirement: Economic life should be definancialised. We should learn not to use markets as warehouses of value.

Make an omelette with the broken eggs: The crisis of 2008 was not a problem to fix with makeshift repairs. We will have to remake the system before it does so itself. Let us move voluntarily into a robust economy by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here and teaching people to navigate a world with fewer certainties. Then we will see an economic life closer to our biological environment: smaller firms and no leverage - a world in which entrepreneurs, not bankers, take the risks, and in which companies are born and die every day without making the news.

Extracted from the postscript to "The Black Swan: the Impact of the Highly Improbable" by Nassim Nicholas Taleb (Penguin, £9.99)
© Nassim Nicholas Taleb 2008 penguin.co.uk

This article first appeared in the 05 July 2010 issue of the New Statesman, The cult of the generals

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As bad as stealing bacon – why did the Victorians treat acid attacks so leniently?

In an era of executions and transportation, 19th century courts were surprisingly laissez-faire about acid attacks. 

"We are rather anxious to see the punishment of death rescinded in all cases except that of Murder," stated the Glasgow publication, The Loyal Reformers’ Gazette, in 1831. But it did not share this opinion when it came to Hugh Kennedy.

Previously of “irreproachable character", Kennedy fell out with a fellow servant and decided to take his revenge by pouring acid on the man while he was asleep. “He awoke in agony, one of his eyes being literally burned out,” The Gazette reported.

Lamenting the rise in acid attacks, the otherwise progressive journal recommended “the severest punishment” for Kennedy:

“We would have their arms cut off by the shoulders, and, in that state, send them to roam as outcasts from society without the power of throwing vitriol again."

More than 180 years later, there are echoes of this sentiment in the home secretary’s response to a spate of acid attacks in London. “I quite understand when victims say they feel the perpetrators themselves should have a life sentence,” Amber Rudd told Sky News. She warned attackers would feel “the full force of the law”.

Acid attacks leave the victims permanently disfigured, and often blinded. Surprisingly, though, the kind of hardline punishment advocated by The Gazette was actually highly unusual, according to Dr Katherine Watson, a lecturer in the history of medicine at Oxford Brookes University. Hugh Kennedy was in fact the only person hung for an acid attack.

“If you look at the cases that made it to court, you see there is a huge amount of sympathy for the perpetrators,” she says.

"You want your victim to suffer but you don’t want them to die”

Acid attacks emerged with the industrial revolution in Britain. From the late 1700s, acid was needed to bleach cotton and prevent metals from rusting, and as a result became widely available.

At first, acid was a weapon of insurrection. “Vitriol throwing (that is, the throwing of corrosive substances like sulphuric acid) was a big problem in 1820s Glasgow trade disputes,” says Shane Ewen, an urban historian at Leeds Beckett University. Other cases involved revenge attacks on landlords and employers.

Faced with this anarchic threat, the authorities struck back. Scotland introduced a strict law against acid attacks in the 1820s, while the 1861 Offences Against the Person Act s.29 placed provided for a maximum sentence of life in England and Wales.

In reality, though, acid attackers could expect to receive far more lenient sentences. Why?

“They had sad stories,” says Watson, a leading historian of acid attacks. “Although they had done something terrible, the journalists and juries could empathise with them.”

Acid attacks were seen as expressions of revenge, even glorified as crimes of passion. As Watson puts it: “The point is you want your victim to suffer but you don’t want them to die.”

Although today, around the world, acid attacks are associated with violence against women, both genders used acid as a weapon in 19th century and early 20th century Britain. Acid crept into popular culture. Arthur Conan Doyle’s 1924 Sherlock Holmes story, The Adventure of the Illustrious Client, featured a mistress throwing vitriol in her former lover’s face. In Brighton Rock, Graham Greene’s 1938 novel, the gangster Pinkie attacks his female nemesis Ida Arnold with his vial of acid, before falling to his death.

Lucy Williams, the author of Wayward Women: Female Offending in Victorian England, agrees that Victorians took a lenient attitude to acid attacks. “Historically speaking sentences for acid attacks were quite low,” she says. “Serious terms of imprisonment would only usually be given if the injury caused permanent blindness, death, or was life-threatening.

“If this was not the case, a defendant might spend just a few months in prison - sometimes even less.”

Courts would weigh up factors including the gender of the attacker and victim, and the strength of the substance.

But there was another factor, far removed from compassion “Many of the sentences that we would now consider extremely lenient were a product of a judicial system that valued property over people,” says Williams. It was quite common for violent offences to receive just a few weeks or months in prison.

One case Williams has researched is that of the 28 year old Sarah Newman, who threw sulphuric acid at Cornelius Mahoney, and was tried for the “intent to burn and disfigure him” at the Old Bailey in 1883. The attacker and victim had been living together, and had three children together, but Mahoney had abandoned Newman to marry another woman.

Although Mahoney lost the sight in his right eye, his attacker received just 12 months imprisonment with hard labour.

Two other cases, uncovered by Ancestry.co.uk, illustrate the Victorian attitude to people and property. Mary Morrison, a servant in her 40s, threw acid in the face of her estranged husband after he didn’t give her a weekly allowance. The attack disfigured and blinded him.

In 1883, Morrison was jailed for five years, but released after two and a half. The same year, Dorcas Snell, also in her 40s, received a very similar sentence – for stealing a piece of bacon.

"People just had more options"

If Victorian attitudes become clearer with research, why acid attacks receded in the 20th century remains something of a mystery.

“My theory is people just had more options,” says Watson. With manufacturing on the wane, it became a little harder to get hold of corrosive fluid. But more importantly, the underlying motivation for acid attacks was disappearing. “Women can just walk away from relationships, they can get divorced, get a job. And maybe men don’t feel the same shame if women leave.”

Acid attacks did not disappear completely, though. Yardie gangs – mainly comprised of Jamaican immigrants – used acid as a weapon in the 1960s. Other gangs may have used it too, against victims who would rather suffer in silence than reveal themselves to the police.

Meanwhile, in 1967, the first acid attacks in Bangladesh and India were recorded. This would be the start of a disturbing, misogynistic trend of attacks across Asia. “Acid attacks, like other forms of violence against women, are not random or natural phenomena,” Professor Yakin Ertürk, the UN’s special rapporteur on violence against women, wrote in 2011. “Rather, they are social phenomena deeply embedded in a gender order that has historically privileged patriarchal control over women and justified the use of violence to ‘keep women in their places’.”

The re-emergence of acid attacks in Britain has been interpreted by some as another example of multiculturalism gone wrong. “The acid attacks of London’s Muslim no-go zones”, declared the right-wing, US-based Front Page magazine.

In fact, descriptions of the recent attackers include white men, and black and minority ethnic groups are disproportionately among the victims. A protest by delivery drivers against acid attacks was led by Asian men. 

Jaf Shah, from the Acid Survivors Trust International, suspects the current spate of attacks in fact originates from gang-related warfare that has in turn inspired copycat attacks. “In the UK because of the number of men attacked, it goes against the global pattern,” he says. “It’s complicated by multiple motivations behind these attacks.” Unlike other weapons in the UK, acid is easy to obtain and carry, while acid attacks are prosecuted under the non-specific category of grievous bodily harm. 

Among the recent victims is a British Muslim businessman from Luton, who says he was attacked by a bald white man, two teenage boys in east London, a delivery man, also in east London, who had his moped stolen at the same time, and a man in Leicester whose girlfriend – in a move Hugh Kennedy would recognise – poured acid on him while he slept.

Shah believes the current anxiety about acid attacks stems from the fact the general public is being attacked, rather than simply other members of gangs. Perhaps, also, it relates to the fact that, thanks to advances in our understanding of trauma since the Victorian period, 21st century lawmakers are less interested in the theft of a moped than the lifetime of scars left on the driver who was attacked.

With Rudd promising a crackdown, the penalties for acid throwing are only likely to get harsher. “Many survivors feel the sentencing is too lenient,” Shah says. Still, the rise and fall and rise again of acid throwing in the UK suggests the best way to eradicate the crime may lie outside the courts.

Julia Rampen is the digital news editor of the New Statesman (previously editor of The Staggers, The New Statesman's online rolling politics blog). She has also been deputy editor at Mirror Money Online and has worked as a financial journalist for several trade magazines. 

This article first appeared in the 05 July 2010 issue of the New Statesman, The cult of the generals