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Monday, December 17, 2012

Antifragile: Things That Gain from Disorder

   This is from a remarkably fine article in the WSJ based on the book Antifragile: Things That Gain from Disorder  (HT Jerry Pournelle's Chaos Manor). I am reprinting his 5 rules of what is required for successful social organisations. Note that each one shows free markets being more able to survive unexpected (black swan) problems (or take advantage of unexpected opportunities than government. Multiplying all 5 together must make a colossal advantage:

Rule 1: Think of the economy as being more like a cat than a washing machine.

...natural or organic systems are antifragile: They need some dose of disorder in order to develop. Deprive your bones of stress and they become brittle. This denial of the antifragility of living or complex systems is the costliest mistake that we have made in modern times. Stifling natural fluctuations masks real problems, causing the explosions to be both delayed and more intense when they do take place. As with the flammable material accumulating on the forest floor in the absence of forest fires, problems hide in the absence of stressors, and the resulting cumulative harm can take on tragic proportions.

And yet our economic policy makers have often aimed for maximum stability, even for eradicating the business cycle. "No more boom and bust," as voiced by the U.K. Labor leader Gordon Brown....

Promoting antifragility doesn't mean that government institutions should avoid intervention altogether...: The state should be there for emergency-room surgery, not nanny-style maintenance and overmedication of the patient—and it should get better at the former.

In social policy, when we provide a safety net, it should be designed to help people take more entrepreneurial risks, not to turn them into dependents.

Rule 2: Favor businesses that benefit from their own mistakes, not those whose mistakes percolate into the system.

..... Without the high failure rate in the restaurant business, you would be eating Soviet-style cafeteria food for your next meal.

....These businesses have properties similar to evolution in the natural world, with a well-functioning mechanism to benefit from evolutionary pressures, one error at a time.

By contrast, every bank failure weakens the financial system, which in its current form is irremediably fragile: Errors end up becoming large and threatening. A reformed financial system would eliminate this domino effect, allowing no systemic risk from individual failures. A good starting point would be reducing the amount of debt and leverage in the economy and turning to equity financing. ....A firm with equity financing can survive drops in income, however. Consider the abrupt deflation of the technology bubble during 2000. Because technology firms were relying on equity rather than debt, their failures didn't ripple out into the wider economy. Indeed, their failures helped to strengthen the technology sector.
Rule 3: Small is beautiful, but it is also efficient.

...Projects of $100 million seem rational, but they tend to have much higher percentage overruns than projects of, say, $10 million. Great size in itself, when it exceeds a certain threshold, produces fragility and can eradicate all the gains from economies of scale. To see how large things can be fragile, consider the difference between an elephant and a mouse: The former breaks a leg at the slightest fall, while the latter is unharmed by a drop several multiples of its height. This explains why we have so many more mice than elephants.

... Compare the success of the bottom-up mechanism of canton-based decision making in Switzerland to the failures of authoritarian regimes in Soviet Russia and Baathist Iraq and Syria.
Rule 4: Trial and error beats academic knowledge.

Things that are antifragile love randomness and uncertainty, which also means—crucially—that they can learn from errors. Tinkering by trial and error has traditionally played a larger role than directed science in Western invention and innovation. Indeed, advances in theoretical science have most often emerged from technological development, which is closely tied to entrepreneurship...

But I don't mean just any version of trial and error. There is a crucial requirement to achieve antifragility: The potential cost of errors needs to remain small; the potential gain should be large.
Perhaps because of the success of the Manhattan Project and the space program, we greatly overestimate the influence and importance of researchers and academics in technological advancement. These people write books and papers; tinkerers and engineers don't, and are thus less visible. Consider Britain, whose historic rise during the Industrial Revolution came from tinkerers who gave us innovations like iron making, the steam engine and textile manufacturing. The great names of the golden years of English science were hobbyists, not academics: Charles Darwin, Henry Cavendish, William Parsons, the Rev. Thomas Bayes. Britain saw its decline when it switched to the model of bureaucracy-driven science. I have expressed strong doubt that NASA is an example of an efficient large programme, it just had an awful lot of money. In an alternate world where there had been no Apollo programme we might be firther ahead now. In one where the money put into NASA had gone into X-Prizes U don't think anybody disputes we would now have settled most of the solar system and be preparing for interstellar travel by now.

Rule 5: Decision makers must have skin in the game.

At no time in the history of humankind have more positions of power been assigned to people who don't take personal risks. ... This has an excellent precedent in the practices of the ancients. The Romans forced engineers to sleep under a bridge once it was completed.

Because our current system is so complex, it lacks elementary clarity: No regulator will know more about the hidden risks of an enterprise than the engineer who can hide exposures to rare events and be unharmed by their consequences. This rule would have saved us from the banking crisis, when bankers who loaded their balance sheets with exposures to small probability events collected bonuses during the quiet years and then transferred the harm to the taxpayer, keeping their own compensation. Nobody is held less responsible for their actions than modern political leaders. Force Brown & Blair to sleep under the british economy and they would have been more careful

In these five rules, I have sketched out only a few of the more obvious policy conclusions that we might draw from a proper appreciation of antifragility. But the significance of antifragility runs deeper. It is not just a useful heuristic for socioeconomic matters but a crucial property of life in general. Things that are antifragile only grow and improve under adversity. This dynamic can be seen not just in economic life but in the evolution of all things, from cuisine, urbanization and legal systems to our own existence as a species on this planet.

Modernity has been obsessed with comfort and cosmetic stability, but by making ourselves too comfortable and eliminating all volatility from our lives, we do to our bodies and souls what Mr. Greenspan did to the U.S. economy: We make them fragile. We must instead learn to gain from disorder.

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