Supercali–fragil-istic

I’m about three-quarters of the way through Nassim Nicholas Taleb’s latest book, Antifragile. This is the third book I’ve read of his, and if you can get around the author’s grumpiness and the book’s somewhat rambling style, Taleb conveys a number of perspectives which border on profound.

I would summarize some of his key points as follows:

1. There is unpredictable volatility in the world and you will be affected by it
2. As the world becomes more interconnected, this volatility increases
3. In such a world, forecasting is useless
4. Organizations/individuals/professions/companies/etc. can be affected by this volatility in one of three ways:

1. Their exposure to the downside risk associated with when things go unexpectedly poorly is greater than their exposure to the upside gain associated with when things go unexpectedly well. Such organizations are called fragile; they are damaged by volatility.
2. Their exposure to the downside risk associated with when things go unexpectedly poorly is approximately balanced by their exposure to the upside gain associated with when things go unexpectedly well. Such organizations are robust; volatility neither harms nor helps them.
3. Their exposure to the upside gain associated with when things go unexpectedly well is greater than their exposure to the downside risk associated with when things go unexpectedly poorly. Such organizations are antifragile; volatility strengthens and enriches them.

A highway is an example of a very fragile (and inefficient) system. With a small number of cars on it, it works as planned – i.e., the travel time to get somewhere is about what you’d expect, given the posted speed limits.Reduce the number of cars on the road, and there really isn’t any significant upside; it still takes about the same amount of time.But as soon as about 10% – 15% of the surface of the road becomes occupied by cars, travel times start to increase – and not in a linear fashion.Each additional car beyond that point causes a decrease in speed which is greater than the decrease caused by the previous additional car.Even with far less than 50% of the surface of the road occupied, traffic comes to a near standstill.

The home mortgage industry is also extremely fragile.The upside potential is fixed; if everyone repays their loans on time, that’s as good as it gets for the banker who made the loan.But the downside risk is enormous (as we saw in 2007-09).Defaults can have a cascading effect throughout the economy – definitely non-linear – resulting in massive losses to the industry (until the taxpayer bails them out, of course).

The world of the venture capitalist, on the other hand, is antifragile.VCs invest in lots of start-up companies, owning a piece of the action in lots of new ideas.A volatile environment (or economy) is actually good for small, “new idea” companies, and companies which change the status quo tend to contribute to the volatility of the economy – a virtuous cycle (if you own a piece of the action).Granted, the vast majority of small start-ups die an early death, but that’s okay as long as you’re expecting it.So VCs, unlike bankers, have a fixed downside (they know what their exposure is, and therefore their maximum losses), but their upside is almost unlimited.They have great option-value potential.

Species are generally antifragile, even though specific individuals within the species are generally fragile.Minor to moderate stresses, all the way up to fairly major disasters (famines, floods, pestilence) can kill many individuals, but the population that survives will be, on average, stronger.

In Taleb’s parlance, the finance curve is concave (when viewed from below); the VC’s curve is convex.In an increasingly volatile world, seek out convexity.

The reasons for this concavity or convexity are second-order effects in complex systems, and these come in several flavors.One type stems from the iterative nature of such systems; what I do affects what you (and others) do, and what you do affects what I (and others) do.The more people we affect, the more interconnected the system, and the more rapidly these effects cascade through the population.These days, with everyone online 24/7, everyone tweeting their every thought, and information (truthful or otherwise) streaming around the world in the blink of an eye, these second-order effects are huge.And therefore, so is the overall system volatility.

A second type of second-order effect comes from unintended consequences.I mentioned in a presentation last year about what the black gold rush in North Dakota has done to rental rates and music volumes up there (on YouTube at https://www.youtube.com/watch?v=_Q-oSd7KOlE).Unintended consequences in other situations go way beyond that.Our striving for ever-increasing efficiencies through just-in-time supply chain delivery, concentrating manufacturing in the cheapest labor markets, and “optimizing” systems like power grids to maximize efficiency during peak usage times has enormously increased the fragility of many industries and our overall economy.One flood in Thailand wiped out much of the auto parts supply chain; one power station going down can black out half of a nation.Taleb is a big fan of reintroducing redundancy into our companies and systems.Doing so increases the convexity of our curve; we have a fixed downside (the increased cost of maintaining spare capacity), but a potentially huge upside (avoiding disaster in the event of a tsunami or a heat wave).Failure to do this is essentially betting that disruptive events won’t happen.That’s a fool’s bet.

How did we get to this state of fragility? In addition to higher degrees of interconnectedness leading to increased volatility, Taleb points out that attempts at eliminating all of the “bumps in the road” – i.e., minor losses, small stresses, mini-crashes – results in systems which sail along much more smoothly for a while, but which are much more susceptible to very large failures. Preventing small forest fires results in heavy underbrush which feeds enormous, terribly destructive fires. Using federal insurance to protect investors from even small losses creates incentives which ultimately build up to crashes of the entire system. Driverless cars which talk to each other and never crash are much safer than human-operated ones – unless a solar flare wipes out the satellites which are coordinating the inter-vehicle communication. Sanitizing every surface in the house has resulted in an entire generation of people with allergies, asthma, and very poorly developed immune systems. I recently read an article in The Atlantic about how children of parents who are always hovering and protecting them from harm grow up without developing any sense of how to judge risks – often resulting in disastrous decisions later in life. Bumps and bruises make us stronger and wiser, both literally and metaphorically.

There is much more to Antifragile than I have covered here, but these are some of the main points of the book.  Nassim Taleb is certainly an original thinker, and his perspectives are well worth pondering and discussing.  More importantly, his perspectives are worth considering when making major decisions in today’s volatile world.