December 5, 2011

"The longer it takes for the blowup to occur, the worse the resulting harm..."

Nassim Nicholas Taleb and Mark Blyth, The Black Swan of Cairo— Foreign Affairs:

Why is surprise the permanent condition of the U.S. political and economic elite? In 2007-8, when the global financial system imploded, the cry that no one could have seen this coming was heard everywhere, despite the existence of numerous analyses showing that a crisis was unavoidable. It is no surprise that one hears precisely the same response today regarding the current turmoil in the Middle East. The critical issue in both cases is the artificial suppression of volatility -- the ups and downs of life -- in the name of stability. It is both misguided and dangerous to push unobserved risks further into the statistical tails of the probability distribution of outcomes and allow these high-impact, low-probability "tail risks" to disappear from policymakers' fields of observation. What the world is witnessing in Tunisia, Egypt, and Libya is simply what happens when highly constrained systems explode.

Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite. These artificially constrained systems become prone to "Black Swans" -- that is, they become extremely vulnerable to large-scale events that lie far from the statistical norm and were largely unpredictable to a given set of observers.

Such environments eventually experience massive blowups, catching everyone off-guard and undoing years of stability or, in some cases, ending up far worse than they were in their initial volatile state. Indeed, the longer it takes for the blowup to occur, the worse the resulting harm in both economic and political systems....
So how can systems be robust in the Information Age? If you follow the author's point that "suppressed volatility" leads to fragility, then where do we see volatility unfettered? Un-suppressed? One place is in the world of business. (Not including the financial sector, which I'm not sure is really "business" anyway.)

In America one can start a business, flare up into the sky like a rocket, and then plummet to the earth and crash and burn—all within a single decade. This, paradoxically, has created a business world that is profoundly stable. How so? Because everything is tested and hammered on all the time. Iron pyrites can't pass as gold for very long. Scams are soon exposed. Individual businesses fail constantly, but the realm of business just grows stronger.

The challenge of the new age we are in is to give other realms the same stability. Above all the realm of government, which we now see failing catastrophically all around us.

. Posted by John Weidner at December 5, 2011 10:42 PM
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