enough to know that it actually could have been far worse, because the past
twenty years did not have a big catastrophe, and all you need is one of those per
century to kiss the business good-bye. Many finance academics doing "valuation"
on insurance seem to have missed the point.
A P P E L L E S T H E P A I N T E R , O R W H A T D O Y O U D O I F Y O U C A N N O T P R E D I C T ? 2 09
an appointment, cancel anything you have planned: you may never
see such a window open up again. I am sometimes shocked at how
little people realize that these opportunities do not grow on trees.
Collect as many free nonlottery tickets (those with open-ended
payoffs) as you can, and, once they start paying off, do not discard
them. Work hard, not in grunt work, but in chasing such opportunities
and maximizing exposure to them. This makes living in
big cities invaluable because you increase the odds of serendipitous
encounters—you gain exposure to the envelope of serendipity.
The idea of settling in a rural area on grounds that one has good
communications "in the age of the Internet" tunnels out of such
sources of positive uncertainty. Diplomats understand that very
well: casual chance discussions at cocktail parties usually lead to
big breakthroughs—not dry correspondence or telephone conversations.
Go to parties! If you're a scientist, you will chance upon a
remark that might spark new research. And if you are autistic, send
your associates to these events.
d. Beware of precise plans by governments. As discussed in Chapter
10, let governments predict (it makes officials feel better about
themselves and justifies their existence) but do not set much store
by what they say. Remember that the interest of these civil servants
is to survive and self-perpetuate—not to get to the truth. It does not
mean that governments are useless, only that you need to keep a
vigilant eye on their side effects. For instance, regulators in the
banking business are prone to a severe expert problem and they
tend to condone reckless but (hidden) risk taking. Andy Marshall
and Andy Mays asked me if the private sector could do better in
predicting. Alas, no. Once again, recall the story of banks hiding
explosive risks in their portfolios. It is not a good idea to trust corporations
with matters such as rare events because the performance
of these executives is not observable on a short-term basis, and
they will game the system by showing good performance so they
can get their yearly bonus. The Achilles' heel of capitalism is that if
you make corporations compete, it is sometimes the one that is
most exposed to the negative Black Swan that will appear to be the
most fit for survival. Also recall from the footnote on Ferguson's
discovery in Chapter 1 that markets are not good predictors of
wars. No one in particular is a good predictor of anything. Sorry.
2 1 0 WE J U S T C A N ' T P R E D I CT
e. "There are some people who, if they don't already know, you can't
tell 'em," as the great philosopher of uncertainty Yogi Berra once
said. Do not waste your time trying to fight forecasters, stock analysts,
economists, and social scientists, except to play pranks on
them. They are considerably easy to make fun of, and many get
angry quite readily. It is ineffective to moan about unpredictability:
people will continue to predict foolishly, especially if they are paid
for it, and you cannot put an end to institutionalized frauds. If you
ever do have to heed a forecast, keep in mind that its accuracy degrades
rapidly as you extend it through time.
If you hear a "prominent" economist using the word equilibrium,
or normal distribution, do not argue with him; just ignore
him, or try to put a rat down his shirt.
The Great Asymmetry
All these recommendations have one point in common: asymmetry. Put
yourself in situations where favorable consequences are much larger than
unfavorable ones.
Indeed, the notion of asymmetric outcomes as the central idea of this
book: I will never get to know the unknown since, by definition, it is unknown.
However, I can always guess how it might affect me, and I should
base my decisions around that.
This idea is often erroneously called Pascal's wager, after the philosopher
and (thinking) mathematician Blaise Pascal. He presented it something
like this: I do not know whether God exists, but I know that I have
nothing to gain from being an atheist if he does not exist, whereas I
have plenty to lose if he does. Hence, this justifies my belief in God.
Pascal's argument is severely flawed theologically: one has to be na?ve
enough to believe that God would not penalize us for false belief. Unless,
of course, one is taking the quite restrictive view of a naive God. (Bertrand
Russell was reported to have claimed that God would need to have created
fools for Pascal's argument to work.)
But the idea behind Pascal's wager has fundamental applications outside
of theology. It stands the entire notion of knowledge on its head. It
eliminates the need for us to understand the probabilities of a rare event
(there are fundamental limits to our knowledge of these); rather, we can
focus on the payoff and benefits of an event if it takes place. The probabilities
of very rare events are not computable; the effect of an event on us is
A P P E L L E S T H E P A I N T E R , O R W H A T D O Y O U D O I F Y O U C A N N O T P R E D I C T ? 2 11
considerably easier to ascertain (the rarer the event, the fuzzier the odds).
We can have a clear idea of the consequences of an event, even if we do not
know how likely it is to occur. I don't know the odds of an earthquake,
but I can imagine how San Francisco might be affected by one. This idea
that in order to make a decision you need to focus on the consequences
(which you can know) rather than the probability (which you can't know)
is the central idea of uncertainty. Much of my life is based on it.
You can build an overall theory of decision making on this idea. All
you have to do is mitigate the consequences. As I said, if my portfolio is
exposed to a market crash, the odds of which I can't compute, all I have
to do is buy insurance, or get out and invest the amounts I am not willing
to ever lose in less risky securities.
Effectively, if free markets have been successful, it is precisely because
they allow the trial-and-error process I call "stochastic tinkering" on the
part of competing individual operators who fall for the narrative fallacy—
but are effectively collectively partaking of a grand project. We are
increasingly learning to practice stochastic tinkering without knowing it—
thanks to overconfident entrepreneurs, na?ve investors, greedy investment
bankers, and aggressive venture capitalists brought together by the freemarket
system. The next chapter shows why I am optimistic that the academy
is losing its power and ability to put knowledge in straitjackets and
that more out-of-the-box knowledge will be generated Wiki-style.
In the end we are being driven by history, all the while thinking that we are
doing the driving.
I'll sum up this long section on prediction by stating that we can easily
narrow down the reasons we can't figure out what's going on. There are:
a) epistemic arrogance and our corresponding future blindness; b) the Platonic
notion of categories, or how people are fooled by reductions, particularly
if they have an academic degree in an expert-free discipline; and,
finally c) flawed tools of inference, particularly the Black Swan-free tools
from Mediocristan.
In the next section we will go deeper, much deeper, into these tools
from Mediocristan, into the "plumbing," so to speak. Some readers may
see it as an appendix; others may consider it the heart of the book.
OfBC?WMISTAN
THOSE ?RAY
SWANS
t's time to deal in some depth with four final items that bear on our
Black Swan.
Primo, I have said earlier that the world is moving deeper into Extremistan,
that it is less and less governed by Mediocristan—in fact, this
idea is more subtle than that. I will show how and present the various
ideas we have about the formation of inequality. Secondo, I have been describing
the Gaussian bell curve as a contagious and severe delusion, and
it is time to get into that point in some depth. Terso, I will present what I
call Mandelbrotian, or fractal, randomness. Remember that for an event
to be a Black Swan, it does not just have to be rare, or just wild; it has to
be unexpected, has to lie outside our tunnel of possibilities. You must be a
sucker for it. As it happens, many rare events can yield their structure to
us: it is not easy to compute their probability, but it is easy to get a general
idea about the possibility of their occurrence. We can turn these Black
Swans into Gray Swans, so to speak, reducing their surprise effect. A person
aware of the possibility of such events can come to belong to the nonsucker
variety.
Finally, I will present the ideas of those philosophers who focus on
phony uncertainty. I organized this book in such a way that the more technical
(though nonessential) sections are here; these can be skipped without
any loss to the thoughtful reader, particularly Chapters 15, 17, and the second
half of Chapter 16.1 will alert the reader with footnotes. The reader less
interested in the mechanics of deviations can then directly proceed to Part 4.
Chapter Fourteen
FROM MEDIOCRISTAN TO
EXTREMISTAN, AND BACK
/ prefer Horowitz—How to fall from favor—The long tail—Get ready for some
surprises—It's not just money
Let us see how an increasingly man-made planet can evolve away from
mild into wild randomness. First, I describe how we get to Extremistan.
Then, I will take a look at its evolution.
The World Is Unfair
Is the world that unfair? I have spent my entire life studying randomness,
practicing randomness, hating randomness. The more that time passes,
the worse things seem to me, the more scared I get, the more disgusted I
am with Mother Nature. The more I think about my subject, the more I
see evidence that the world we have in our minds is different from the one
playing outside. Every morning the world appears to me more random
than it did the day before, and humans seem to be even more fooled by
it than they were the previous day. It is becoming unbearable. I find writing
these lines painful; I find the world revolting.
Two "soft" scientists propose intuitive models for the development of
this inequity: one is a mainstream economist, the other a sociologist. Both
simplify a little too much. I will present their ideas because they are easy
' 2 1 6 THOSE GRAY SWANS OF EXTREMISTAN
to understand, not because of the scientific quality of their insights or any
consequences in their discoveries; then I will show the story as seen from
the vantage point of the natural scientists.
Let me start with the economist Sherwin Rosen. In the early eighties,
he wrote papers about "the economics of superstars." In one of the papers
he conveyed his sense of outrage that a basketball player could earn $1.2
million a year, or a television celebrity could make $2 million. To get an
idea of how this concentration is increasing—i.e., of how we are moving
away from Mediocristan—consider that television celebrities and sports
stars (even in Europe) get contracts today, only two decades later, worth in
the hundreds of millions of dollars! The extreme is about (so far) twenty
times higher than it was two decades ago!
According to Rosen, this inequality comes from a tournament effect:
someone who is marginally "better" can easily win the entire pot, leaving
the others with nothing. Using an argument from Chapter 3, people prefer
to pay $10.99 for a recording featuring Horowitz to $9.99 for a struggling
pianist. Would you rather read Kundera for $13.99 or some
unknown author for $1? So it looks like a tournament, where the winner
grabs the whole thing—and he does not have to win by much.
But the role of luck is missing in Rosen's beautiful argument. The problem
here is the notion of "better," this focus on skills as leading to success.
Random outcomes, or an arbitrary situation, can also explain success, and
provide the initial push that leads to a winner-take-all result. A person can
get slightly ahead for entirely random reasons; because we like to imitate
one another, we will flock to him. The world of contagion is so underestimated!
As I am writing these lines I am using a Macintosh, by Apple, after
years of using Microsoft-based products. The Apple technology is vastly
better, yet the inferior software won the day. How? Luck.
The Matthew Effect
More than a decade before Rosen, the sociologist of science Robert K.
Merton presented his idea of the Matthew effect, by which people take
from the poor to give to the rich. * He looked at the performance of scien-
* These scalable laws were already discussed in the scriptures: "For onto everyone
that hath shall be given, and he shall have abundance; but from him that hath not
shall be taken away even that which he hath." Matthew (Matthew 25:29, King
James Version).
F R O M M E D I O C R I S T A N T O E X T R E M I S T A N , A N D B A C K 2 17
tists and showed how an initial advantage follows someone through life.
Consider the following process.
Let's say someone writes an academic paper quoting fifty people who
have worked on the subject and provided background materials for his
study; assume, for the sake of simplicity, that all fifty are of equal merit.
Another researcher working on the exact same subject will randomly cite
three of those fifty in his bibliography. Merton showed that many academics
cite references without having read the original work; rather, they'll
read a paper and draw their own citations from among its sources. So a
third researcher reading the second article selects three of the previously
referenced authors for his citations. These three authors will receive cumulatively
