The same wind that snuffs the candle enlivens the bonfire. When the winds of chaos come to your life, aim to be the bonfire not the candle.
— Nassim Taleb
No one escapes the cruel hands of probability. Yet we often only use the most shallow tools to think about fate's grasp on our life. Nassim Nicholas Taleb has categorized the goddess of chance in his series Inconcerto. This article is a summary and toolset for three of those books: Fooled by Randomness, The Black Swan, and Antifragility.
When analyzing events and systems, it is natural to ascribe every outcome to the specific circumstances leading up to it. There are many situations where success is random, such as investing or predicting the survivors of an artillery bombardment. In these situations, your skills and efforts have an impact but circumstances outside your control often decide the outcome.
Mediocristan and Extremistan
Taleb introduces the concepts of event likelihood and event impact using two examples: Mediocristan and Extremistan. In an article called Travels Inside Mediocristan, Taleb writes:
Let's play with the following thought experiment. Round up a thousand people randomly selected from the general and have them stand next to each other in a stadium. Imagine the heaviest person you can think of and add him to that sample. Assuming he weighs three times the average, between four hundred and five hundred pounds, he will rarely represent more than a very small fraction of the weight of the entire population.
You can get even more aggressive. If you picked the heaviest biologically possible human on the planet (who yet can still be called a human), he would not represent more than, say, 0.6 percent of the total, a very negligible increase .
Consider by comparison the net worth of the thousand people you lined up in the stadium. Add to them the wealthiest person to be found on the planet — say Bill Gates. Assume his net worth to be close to $80 billion, with the total capital of the others around a few million. How much of the total wealth would he represent? 99.9 percent?
Later, Taleb provides another example of Extremistan: book publishing. Suppose one randomly chooses a thousand authors and adds up their total sales. Now, add the bestselling author in the world: J.K. Rowling. Her book sales vastly exceed the total of the other thousand authors.
The critical point that Taleb is making is that in the country or "domain" of Extremistan, the cumulative magnitude of an outlier, such as Bill Gates, is on an entirely different scale than it is in the domain of Mediocristan.
In Extremistan, inequalities are such that one single observation can disproportionately impact the total. So while weight, height, and calorie consumption are from Mediocristan, wealth is not. Almost all social matters are from Extremistan.
A key implication of this distinction is that in Mediocristan, the overall impact of an outlier is not that significant relative to the total, but in Extremistan, that impact is enormous.
Consequently, if we are in the domain of Extremistan, and we use analytical tools from Mediocristan for prediction or risk management, we can face enormous surprises. Some of these surprises may be positive. Others may be negative. More importantly, these surprises will have an impact exceeding our preparations.
Taleb's central critique of the Bell Curve — "That Great Intellectual Fraud" — is that it is often applied to areas that are subject to the dynamics of Extremistan, even though it only accurately describes Mediocristan.
When you look at a system to analyze, start by asking whether it's in the domain of Mediocristan or Extremistan. Remember that:
- In Mediocristan, single events have minimal impact
- In Extremistan, single events have outsized impacts
If you're unsure whether single events can be impactful, look at the history of black swans (rare events) in similar conditions. How did people react to them? Trust history more than models.
The next step is to do risk assessment. Fill out a grid similar to the one below, remembering that randomness is higher than it seems (because failures are often invisible). What plan do you have in place for dealing with each of the four scenarios?
|Low likelihood||High likelihood|
Modern agriculture relies on many inputs: land, machines, chemicals, and — increasingly — industrialized seeds. Major disruptions to any of these inputs causes a sharp drop in total output, making the likelihood of a crash high. Since a crash can affect many far-flung areas of the world, each crash also has a high impact.
In other words, modern agriculture lies within the domain of Extremistan: single events have an outsized impact on the final outcome.
On the other hand, traditional agriculture (pre-industrial revolution farming) had only land and labor as inputs. With fewer inputs, the likelihood of a crash is reduced. Furthermore, inputs were typically provided locally, which meant that a crash in one area was unlikely to affect distant regions. This places traditional agriculture firmly in the domain of Mediocristan.
Systems can be classified in the following three ways: fragile, robust, and antifragile.
Fragile systems are similar to the modern agriculture example. If anything breaks in a fragile system, the entire system stops working.
Robust systems are capable of working in a wide variety of circumstances. Changes to the environment typically don't provoke a change in a robust system.
Antifragile systems change rapidly when under pressure. Where a fragile system breaks in response to a shock, and a robust system ignores the shock, an antifragile system gets stronger.
Example. A glass of water is a fragile system. Any disruption to the glass (such as it being knocked off a table) causes it to stop being "a glass of water" and start being "a mess".
A block of tungsten in the same conditions is robust. It's unlikely to change much, even under extreme conditions.
Bones and muscles thrive under pressure and both growing stronger when strained.
Two important rules
Efficiency comes at the cost of antifragility.
To make something efficient is to remove redundancy and waste, but that "fat" gives you a reserve if something goes wrong. Saving money as cash instead of investing is inefficient — until the market crashes and you can buy at a discount.
If an economist had designed humans we would each only have one kidney and lease the other if we needed it for efficiency’s sake.
Antifragile systems have a limit.
A bullet is not the same as a hundred bench presses. Every system has tolerance limits. Even if they can eventually withstand a given shock, there is no guarantee that they will be able to withstand it right now. Knowing where those boundaries are is important.
Given all this, the question to ask yourself is How can I be on the side such that all black swans are positive, making me antifragile? (Remember that black swans are rare, high impact events).
Example. The Chinese mortgage market is extremely efficient at creating buildings and profit. However, it's built on a "always a bigger sucker model" that is vulnerable to loss of trust.
A person without the concept of antifragility would see the market's increasing value and invest in Chinese real estate developers. A wiser person would short the companies instead, knowing that eventually the fragile system would break.
Example. Suppose you have the opportunity to move for a job for a minimum of six months. This exposes you to risks, but many of them are the same risks that you would have had at home. In contrast, the new opportunities are very antifragile.
The ability to return to security is essential. Without that safety, "antifragility" becomes risk-taking brinkmanship.
Example. The barbell strategy is a heuristic that tells us to place 80% of our resources in safe options. It's based on the idea that risk is more prevalent and powerful than we assume. This simple rule tends to create robust systems: no matter what happens, 80% of your resources will be relatively safe.
We can do better. Invest the remaining 20% of resources into rare, high-payout options. Most of the money spent on these risky ventures will fail, so it's crucial to never gamble with money you need. However, by investing in these high-risk, high-reward options, you'll expose yourself to the impact of positive black swans.