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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The war within wars

Why the Western-backed assault on Islamic State in Iraq and Syria is failing.

The first signs of a Western-backed attempt to recapture Raqqa, ­Islamic State’s de facto capital in Syria, came a fortnight ago when fighter jets dropped leaflets over the city telling residents to leave. “The time has come,” the warnings read, alongside an illustration of residents evacuating the city as incoming forces overran IS fighters.

Although up to half of Raqqa’s residents fled when IS first took control of the city in 2014, the militants have made it ­increasingly difficult for the people who stayed behind to leave. Following the US-led coalition’s warnings of an impending attack, however, the jihadis relaxed their restrictions on movement. Citizens were allowed to disperse into the nearby countryside. The idea was to spare them whatever onslaught was planned against Raqqa while keeping them within IS territory.

Ever since the latest offensive against IS began in Syria and Iraq in late May, it has become clear that the group will not concede territory easily around Raqqa – or elsewhere. It might lose small villages from time to time, but all of its major urban centres remain well fortified. Few observers expect them to fall any day soon. IS has too much invested in Raqqa, as well as Mosul in Iraq. Occupying the cities fuels the group’s prestige by projecting the impression of ­viable statehood and by allowing it to house fighters and military equipment.

Raqqa is the nerve centre of IS operations. Several training camps are located on its outskirts, including those used to plan attacks against the West. IS has long anti­cipated a revanchist campaign against its Syrian base and has fortified the city by surrounding it with trenches and landmines to thwart any hostile advance.

What makes the fight against IS even more challenging is that its fighters are not easily disheartened. Before this latest campaign, I spoke by Skype to a British fighter from High Wycombe, Buckinghamshire, about how the group perceives territorial losses. He responded with the kind of fatalistic indifference that only the faithful enjoy. Their obligation, he told me, was simply to try their best. The challenge for them was to fight with all they have. Results come from Allah, so, if defeat and setbacks follow, then it is the will of God.

There are two possible interpretations, in their reasoning, for why God might not deliver success for them – because He is punishing or testing them. Either way, the conclusion is the same: to double down on their commitment. In that spirit, they are resolved to fight until victory or martyrdom – and both outcomes represent success. This reasoning shows just how hard it can be to erode the morale of IS’s most doctrinaire fighters (though not all are so zealous in their commitment).

***

The ground push for Raqqa has been overseen by the Syrian Democratic Forces (SDF), which are led principally by the YPG, an ethnically Kurdish unit of fighters concentrated in north-eastern Syria. Although the SDF officially claims to be an umbrella movement for more than 20 different fighting groups – some of which are Arab – its heavily Kurdish composition has made it a reluctant and unsuitable partner in the push to liberate Raqqa.

To understand the reasons why, it is necessary to parse the conflict into its constituent parts. We often hear about the sectarian dimensions of the Syrian civil war, yet this is just one aspect of a much broader tapestry. Syria is a series of wars within a war. Just as there are sectarian components, there are strong ethnic dimensions, too. These are especially pronounced in the northern regions where the Kurds, with their cultural and linguistic distinctiveness, stand apart from their Arab neighbours.

The Kurds have usually formed defensive fighting units in the Syrian conflict, preferring to safeguard and administer their own areas rather than acquire new territory such as Raqqa. Another issue is that Arab ­civilians are reluctant to have non-Arabs push into their cities. The anti-IS activist group Raqqa Is Being Slaughtered Silently (RBSS) says that residents worry about ethnic retribution against an Arab population that is seen as having historically oppressed the Kurds. Many reason that it is better to keep IS and deal with the devil they know.

Those fears are not unfounded. With the horrors of IS and the Syrian army so magnified, it is easy to forget that every fighting group in this conflict has violated human rights and continues to do so. The Kurds are no exception; in October, Amnesty ­International accused Kurdish fighters of war crimes after they razed Arab villages in al-Hasakah and al-Raqqa Governorates. All of this adds to the intractability of the war, forcing people to seek security within their communal, sectarian or ethnic circles. Syrians are hardly unique in this respect; they are merely repeating a pattern of countless conflicts around the world.

This makes it extremely difficult for the West, which is reliant on local forces to do the fighting. The US is supporting al-Hashd al-Shaabi (meaning “popular mobilisation committee”), a nominally Iraqi force leading the assault against IS in Fallujah. Iraq’s prime minister, Haider al-Abadi, has made two main claims about al-Hashd al-Shaabi: that it is a non-sectarian movement of ordinary Iraqis from all sections of society who want to drive IS from the country, and that its leadership reports to him personally.

Neither of these claims is accurate. It is true that some divisions of al-Hashd al-Shaabi comprise Sunni fighters, but it is overwhelmingly dominated by Shias. Its military campaigns are directed not from Baghdad, but Tehran. These efforts are overseen by Qasem Soleimani, a celebrated Iranian major general in the elite Quds Force, who is perhaps the most important military official with a battlefield presence in Syria and Iraq. He previously orchestrated several successful campaigns for President Bashar al-Assad and the al-Abadi force.

Though the ongoing assaults on Raqqa and Fallujah have put IS under pressure on two fronts, anyone hoping this might signal a turning point in the conflict is likely to be disappointed. For every push that shunts IS backwards – often only marginally – many new recruits are spawned.

Videos released on social media from the latest assault on Fallujah appear to show how incoming Shia fighters have beaten and tortured Sunni civilians. The pictures of abuse are overlaid with sectarian slurs, often invoking sensitive points of disputed Sunni/Shia theology. These resound across the region and arguably do even more damage than the images of abuse.

The rapid deterioration in sectarian relations that followed the 2003 invasion of Iraq explains how IS was able to capture Sunni areas of Iraq with such ease. Ordinary residents do not necessarily agree with the authoritarian strictures of its regime, but they mostly understand them. These latest outrages from incoming al-Hashd al-Shaabi fighters will only fuel the belief among Sunnis that they are best served by Sunni administrations – however brutal.

Islamic State has repeatedly invoked the vulnerability of the Sunnis across the Levant to justify its violence. This is the constituency in whose name it claims to act and whose interests it claims to defend.

Shortly after IS first captured Mosul, in June 2014, the group released a video, aimed at Iraqi Sunnis, explaining how both the West and Iraqi Shias had conspired against them in 2003. The result had been a decline in Sunni fortunes and increased insecurity as Shia death squads sought revenge after decades of repression and abuse.

This resonated strongly with Sunnis such as the Albu Mahal and al-Qa’im tribes, which had supported the US-led “awakening”, a military strategy initiated in 2005 to encourage Sunni Iraqi tribes to fight against the insurgency initiated by al-Qaeda. IS captured the heads of those tribes and forgave them for fighting alongside the West against al-Qaeda in Iraq. We are not accustomed to seeing videos of IS pardoning captives, but this was as careful and calculated as any of its ultra-violent theatre. The exercise was designed to project the group as a bastion of Sunni honour and security.

That is the story behind so much of IS’s strength today: the fears of the vulnerable Sunni poor over whom militants govern. Remove that constituency, and the group would collapse. But the Obama administration has done little to allay Sunni fears. Rather, it has exacerbated them by launching air strikes against IS targets in Fallujah, fuelling a perception that it is working hand-in-glove with Shia militias loyal to Iran.

***

The latest attempt to seize IS terri­tory points towards a more pressing question: what, actually, is Islamic State? During a recent meeting at the Foreign and Commonwealth Office, one analyst brilliantly described the mercurial nature of the group. To residents of Raqqa, it appears as a proto-state, replete with all the nomenclature of statehood: an executive, judiciary, police force and civil administration. To rebel groups in the north and for President Assad in Syria, it is more of an aggressive insurgent movement with which there are periodic battles for control of land. For the French and Belgians, it feels more like a conventional terrorist group that deploys suicide bombers and gunmen to kill as many civilians as possible.

Such is the kaleidoscopic nature of IS that there is no reason why it cannot assume multiple forms at the same time, or why it can’t move from one to the other. If the territory in which it operates is overrun, it will revert to being a conventional terrorist movement that unleashes waves of attacks against the West and others. IS has already demonstrated both its willingness and ability to strike in Europe, Egypt, Lebanon, Saudi Arabia, Tunisia and Turkey.

It now also appears an American man, Omar Mateen, self-identified with Islamic State and affiliated himself to the group in order to carry out the most deadly act of US domestic terrorism since the 11 September 2001 attacks. Mateen killed 49 revellers, and injured more than another 50, at a gay bar in Orlando, Florida, on 12 June. The ability of individuals to align themselves with IS despite having no tangible links to it underscores the difficulties of acting decisively against the group. Indeed, this is precisely what IS has advocated. A few days ago, its official spokesman, Abu Muhammad al-Adnani, repeated his call for individuals to launch attacks in the West on the group’s behalf. Following the Orlando massacre, supporters have already suggested copycat attacks in Paris, London and Washington.

By way of comparison, let’s consider what al-Qaeda looked like on the day after the 9/11 attacks. What the West faced was a small group – of perhaps 500 key individuals, if we’re generous – committed to its programme of global jihad. By contrast, even conservative estimates today place ­Islamic State’s manpower somewhere in excess of 20,000. And no one has yet convincingly addressed how to mitigate the threats that will emerge from the region should IS suffer a sudden loss of territory.

IS’s control of large parts of Syria and Iraq will not end quickly. Not only is the group embedded and emboldened, but it enjoys the strategic advantage that comes with being able to operate across two (however nominally) sovereign states. In that respect, the Syrian and Iraqi crises embody all the difficulties of the last hyphenated conflict of the past decade, the so-called challenge of “Af-Pak” (Afghanistan and Pakistan). There, the US found that whenever it pushed against Taliban fighters in Afghanistan, they disappeared over the border. When Pakistan did the same, insurgents moved the other way.

Many of the same issues undermine Western-backed attempts to eradicate IS today. When it allowed civilians to move from Raqqa into the countryside, its own families, fighters and supporters were moved
as well. It has also begun moving critical personnel and heavy arms out of Raqqa, repositioning them near the Iraqi border. In the unlikely event that its operations in Syria are severely compromised, it will fall back into its Iraqi hideouts, and vice versa.

Pressuring IS, therefore, is like squeezing the air in a balloon: push on one area and it moves to another place. In Syria, even as IS militants fight to defend their territory in Raqqa, they have made gains in the ­Aleppo Governorate, moving ever closer to the strategic town of Azaz. Whoever controls Azaz also controls the nearby Bab al-Salam border crossing with Turkey, an important source of revenue and influence. IS previously occupied Azaz but abandoned it in 2014 to consolidate its control in Raqqa. That the group is close to recapturing Azaz at a time when the Obama administration wants to suggest that IS faces an existential crisis shows just how fissiparous and ­intractable this conflict remains.

Shiraz Maher is an NS contributing writer and the deputy director of the International Centre for the Study of Radicalisation at King’s College London. His book, “Salafi-Jihadism: the History of an Idea”, is newly published by C Hurst & Co

Shiraz Maher is a contributing writer for the New Statesman and a senior research fellow at King’s College London’s International Centre for the Study of Radicalisation.

This article first appeared in the 16 June 2016 issue of the New Statesman, Britain on the brink