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

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

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"Overnight, my school emptied": the story of a European border checkpoint

At a busy checkpoint between Turkey and Bulgaria near the Greek frontier, a long history of displacement and exile emerges.

“Bye-bye, komshu,” said the taxi driver. The Turkish word for “neighbour” is used throughout the Balkans.

We had reached the vici­nity of the Kapikule/Kapitan Andreevo checkpoint and he could go no further. We had driven past the mile-long queue of lorries waiting to be processed into the ­European Union. Some drivers waited for days and had come prepared: fold-up stools and portable stoves lined the road. I wondered what the sealed bulks of the lorries contained, and how much of it was fully known to their drivers.

A week earlier, I had crossed the other way – into Turkey – and witnessed a distressing bust by Bulgarian police of young Kurdish stowaways. The lorry driver seemed genuinely shocked, and he was in trouble. Lone women crossing this border in rented cars were regarded with suspicion, too: a Rom­anian woman had recently been caught with hard drugs inside the seats. In another recent incident, a smuggler had accelerated through customs and run over a border cop standing in his way. The smuggler was now in jail, the cop in a coma.

“Hello, arkadash,” said the new taxi driver as he loaded up my bag. Arkadash is Turkish for “mate”, also widely used in the Balkans. This driver had two cars: one with Turkish number plates, for domestic use, and another with Bulgarian plates, for border
purposes. We drove into customs. Slowly.

I was leaving behind the ­mosque-studded border town of Edirne and would soon reach the factory-filled border town of Svilengrad. Ruined factories, that is. For centuries, before the wounded leviathan of the planned economy collapsed, Svilengrad had produced silk. Today, it produced nothing. It was a transaction terminal for the pleasure-seeking populace of the three border nations: Turkey, Greece and Bulgaria. Here were casinos called “Pasha”, “Ali Baba” and “Saray” that promised “shows, prizes and many more surprises”. On the outskirts of town, in a former border army building, was a refugee camp that promised nothing.

The twin border cities of Svilengrad and Edirne sat in the fertile plains of Thrace where a section of the Roman Via Diagonalis passed and where everything grew: vines, sunflowers, cotton, wheat, and what early travellers described as the best watermelons in the Levant. Now the Greeks came across the border to both cities, to get what they needed, cheaply – including haircuts in Bulgaria and fake Levi’s jeans in Turkey. The checkpoint with Greece was just a few miles to the west, and from the last sleepy Greek town, Kastanies, across the swollen waters of the Evros-Maritsa River, you could see Edirne sprawled like a concubine in the haze of the Thracian plains.

The three border rivers (Arda, Tundja, Evros-Maritsa) flooded almost every year: if a dam upstream in Bulgaria opened a sluice, both Turkey and Greece would be flooded. Indeed, this border has seen many spillovers and upheavals over the years, including the catastrophic “exchange of populations” after the Balkan Wars of 1912-13, when borders were redrawn and many in Bulgaria, Greece and Turkey found themselves in alien territory overnight. They had to run for their lives across the new lines.

The road under the wheels became bumpy, a sign that we had crossed into Bulgaria. Ahead of us in the haze rose the communist-era apartment buildings of Svilengrad. In my youth, this area – like all towns, rivers and mountains that fell within 30 kilometres of the national border – was a militarised zone.

The border was a taboo subject. Hidden by Balkan peaks and electrified by Soviet technology, it was everywhere, like the state. The border was that which never slept. It was near the Black Sea beaches where, in my childhood, we went for holidays along with the East Germans, Poles and Czechoslovaks – some of whom went swimming towards Turkey, or made a run for the land border and got shot by Bulgarian guards. It was near the mountain villages where we went to pick berries and climb fir trees from which you could see Greece.

“Do you go to Greece?” I asked Ibrahim, the taxi driver. He had once been a schoolteacher.

“What would I do in Greece?” he replied, smiling. “I don’t speak Greek. This is my patch, here, Turkey and Bulgaria.”

Ibrahim was an ethnic Turk but his family had lived in Bulgaria for many generations. Bulgaria’s ethnic Turks account for roughly 10 per cent of the population, a natural effect of the long cosmopolitan centuries of these once Ottoman lands. But in the summer of 1989, just months before the fall of the Berlin Wall, Ibrahim and another 340,000 Bulgarian Turks passed through this checkpoint with all their worldly possessions. It was the largest exodus in Europe since the Second World War – but in peacetime.

They had been left with little choice in communist Bulgaria, where assimilation campaigns had been waged against them and other Muslims at frequent intervals during the Cold War. The last such campaign forced ethnic Turks with Muslim names to change them to Christian (Slavic) ones. In some parts of the country, even the names of the dead were changed in registries and on gravestones – an act of violence that strikes me as especially cruel.

This self-wounding campaign by the communist state was a diversionary tactic: despotic regimes need enemies. Ethnic minorities are easy prey. Those who resisted were told by the state to clear off to Turkey, and Bulgarian officials opened this checkpoint. Until then it had been closed to all Bulgarian citizens and was used only by Western travellers to Turkey or Turkish Gastarbeiter to Germany.

Ibrahim had been a young teacher in a town at the foot of the Balkan Mountains. “But what is a teacher without kids? Overnight, my school emptied,” he said.

Ibrahim decided to follow, although he spoke no Turkish. He departed alone, leaving behind his mother and sister, who couldn’t face a life of exile and took the new names instead. For the first few years, he lived in a leaking tent in a huge refugee camp in Edirne – where he saw some of his former pupils. He attended evening Turkish classes and eventually found his feet.

Many of those who had crossed the border that summer returned to Bulgaria after the collapse of the communist regime in 1990, reclaimed (or bought back) their houses, and started again. But many remained in Turkey and made new lives for themselves. Families were split down the middle. Today, entire neighbourhoods of Edirne and Istanbul are populated by Bulgarian Turks; one nation’s loss became the other nation’s gain. Then there were those, like Ibrahim, who continued to live a split life.

“Because my memories are all here, you see,” he said, without malice. “My mother, my sister, the old neighbours. But my wife, my kids, my business, are there.” He gestured back towards Turkey.

How do you feel, I asked him, when you see the refugees today? He shook his head. “It’s your pride that goes, you see. Back home, you were a person. With a history, with a future. When you become a forced exile . . .” He trailed off. “The life of an exile is worse than war.”

We arrived at the hotel in Svilengrad where I had booked a room. Ibrahim took out my bag and placed it on the pavement. “Bye-bye, arkadash,” he said; and standing by my bag, I watched him drive down the broken road back to the border.

Today, the Kapikule/Kapitan Andreevo checkpoint is said to be the world’s busiest land crossing. But back in 1989 Ibrahim had crossed this checkpoint alone, on foot. I will always think of him like this: a young teacher with a suitcase, walking through no-man’s-land, into the unknown.

Kapka Kassabova’s “Border: a Journey to the Edge of Europe” is published by Granta Books 

This article first appeared in the 09 March 2017 issue of the New Statesman, The return of al-Qaeda